“I’ve got an Investment Property”
Many of us think the road to financial freedom comes from having an investment property, letting the tenant pay the mortgage and writing off any losses on our tax. However, there are a number of tax traps for the unwary. I can’t advise you whether having investment properties is good or bad, but I can open your eyes to some of the tax issues.
What names should the property be bought in?
Joint ownership
Many couples think “OK. We own our house jointly, we will own all our investments jointly.” They buy the investment property jointly. At the time they are both in the workforce. A couple of years later they have a child and Mum or Dad takes a year off work to look after the new baby.
Obviously, in that year the parent who is caring for the child at home earns very little income. The family comes to get their tax done and says Stan’s income was only $10,000 because he was looking after our bundle of joy. We want to claim all the losses on the investment property against Kirrilee’s income. Sorry, the Tax Office says the income and expenses from a rental property need to be allocated in proportion to the ownership of the property. So if Stan and Kirrilee each own 50% of the investment property, then that’s how it has to be shown in the individual tax returns.
Family Trust
Well then how about buying using a family trust? If the trust makes a tax loss on the investment property, that loss is locked up in the trust. Beneficiaries in the trust can’t claim any part of the trust’s losses in their income tax return. You’ve just got used to that idea and then you get a letter from the Office of State Revenue. “Dear Stan and Kirrilee’s Trust. Here’s a bill for land tax.” Family trusts pay land tax on the land held in the trust at the maximum rate for land tax.
Repairs
You’ve been looking at houses and you’ve found your investment property. It’s in pretty good condition but it needs a few things done to it:
For example, it needs painting. It’s going to cost $10,000 to get the house painted. So we’ll get that done and claim that on the tax. If you’d had the investment for several years and then repainted, the cost of painting would generally be tax deductible. But you’ve just bought the house. The Tax Office takes the view that most repairs you do soon after you buy an investment are repairs that are needed so you can rent the house out. These repairs called “initial repairs” are not deductible but form part of the cost base of the property for capital gains. The Tax Office will allow you to claim $250 a year for the next 40 years.
A few years down the track you decide the wooden verandah needs to be repaired. You concrete it. This is not a repair but a replacement so the cost can’t be deducted as a repair.
Interest
You’ve been working hard. You’ve put your overtime pay for the last few years into your loan on the investment property and now it’s time to treat yourself. So you’re $30,000 ahead on the loan and you redraw it to buy a caravan or go on an overseas trip. You see your tax preparer at the end of the year and they say “you’ve paid more interest this year than the previous year” You say “No worries, I got ahead on the loan and I withdrew that extra money to go overseas” Your tax preparer is then going to say “ Sorry Kirrilee the interest on the amount you withdrew is not going to be deductible” You say “Hang on, that can’t be right. It’s still on the loan and it’s the extra payments I put in.” Your tax preparer then says “The tax law looks at what the loan is used for. It treats your redraw as a new loan which is not being used to produce assessable income.”
Capital gains
Where do we start? It’s important to keep good records. I had a client come in last year. Anna (not real name) said I’ve sold a couple of properties and I know I’ll be up for capital gains. So I asked a few questions. She’d bought one to live in. She moved in as soon as possible after settlement and lived in it until she moved into a second property she’d bought. She’d moved into the second property as soon as she’d settled and lived in it as her main residence. She’d then moved to Port Macquarie and within 6 years of moving to Port she sold that property. She hadn’t bought a property in Port to live in. So I said OK you won’t have to pay capital gains tax on the second property as we can use the main residence exemption. Now how was the first property used after you moved out. She said my son had been living with me and he stayed in the flat after I moved out. The son hadn’t paid rent. So I said to Anna we can reduce the capital gains tax as we can add the cost of expenses you have paid like strata fees, rates, insurance premiums, repairs you’ve paid for to the cost base. She didn’t have that stuff? Why should she, but she got busy and after a fortnight or so she had got the information from the council, strata, water board and insurance. As a result her capital gains tax reduced from $12,000 plus to about $5,000. But wouldn’t it have been easier if she’d kept it all or had scanned it.
A free kick
Depending on when your investment property was built you might be able to claim building write off based on the construction cost of the building at the time it was built. There are a lot of rules about calculating the construction cost so it can’t be guessed but needs to be done by a quantity surveyor or other qualified professional.
The report will probably cost around $600. The cost of the report is tax deductible.
One quantity surveyor I spoke to was amazed at the number of people who don’t think it is worthwhile to get.
However, an example I have is a client in Western NSW. He bought a small industrial building for $135,000. At that time it was quite common for property to sell well below replacement cost. He got a quantity surveyor to drive out to assess the property. He asked the QS to not only provide the construction cost, but also the replacement value for insurance.
The construction cost was $236,000 – so $5,900 a year could be claimed for the next 30 odd years, the buildings were a bit under 10 years old. The replacement cost for insurance was just under $400,000.
Now the loan is paid back he gets after expenses are paid about $2,000 a month in rent and can then claim almost $500 a month in the building write off. So he gets $2,000, $500 is tax free (the building write off) and pays tax on $1,500.
People in that town often say to him “You’re mad. Why did you buy that?” to which he just smiles and talks about something else.
Property tax webinar
As you can see I have just skimmed the surface here. I will be holding a property tax webinar on Wednesday 29 September at 7.30 pm for about one hour. Please submit any questions you have when registering for the webinar.
Free gift
Attendees at the webinar will receive my free eBook Property and taxes for the investor.
About John Clarke, Success Tax Professionals
John is the owner of Success Tax Professionals in Port Macquarie. John is passionate about financial sustainability and enjoys helping businesses increase profits and improve cash flow by finding the hidden cash in their businesses.
Businesses and individuals come to John for their tax, tax planning, and business advice for asset protection and risk management.
Contact John
a/ 6/114 William Street, Port Macquarie, NSW 2444, Australia
t/ 0481 039 851
Disclaimer:
The advice here is general in nature and readers should seek their own advice for their specific circumstances.
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