Tax should be a key factor in any property investor’s strategy. It’s right up there with location, vacancy rate and various other considerations.
Getting tax right in your strategy can mean stopping a whole lot of your wealth from unnecessarily lining the government’s pockets and amplifying your success by putting it to better use elsewhere.
The first thing to do is arm yourself with an understanding of the different types of tax that affect property investment.
The big one straight up is stamp duty. This is a tax you incur when you buy a property and it’s significant enough to keep a lot of people out of the market. Bracket creep has meant that as medians have risen, the amount of stamp duty you pay has soared. The rate is different state by state, but generally, a median priced property will these days set you back tens of thousands of dollars in stamp duty. And it’s an upfront payment, so you’ll need to have that money available on top of whatever you have got for your deposit.
Land tax is another important one as land is where most of the value lies in Australian property. Land tax is levied annually based on the value of your land. Again, threshold and rates differ between states so check out the government website in your jurisdiction for more info.
Finally, there’s capital gains tax (CGT). This is a tax on the profit you make when selling an investment property. It doesn’t affect your permanent place of residence (PPOR). There are government incentives and discounts for investors that hold their asset long term, while those favouring a short term flip and sell strategy might find CGT eats into their gains.
Tax advantages of investing
Real estate ownership provides a number of tax benefits.
One that can be overlooked is depreciation, which allows investors to claim tax deductions for the diminishing value of their asset’s building structure and the fittings within.
Negative gearing is another one. It occurs when the expenses involved with owning a property add up to more than the rental income it generates. Interest on loan repayments, maintenance costs and property management fees are examples of such expenses.
Negative gearing is especially popular with high net worth individuals, looking to reduce short term taxable income, while amassing long term capital gain.
Choosing tax friendly locations
The geographical area you choose to invest can sometimes be beneficial.
There are a number of regional areas around Australia that offer government incentives to attract investors, such as reduced stamp duty or land tax. Check state government websites or ask your buyers’ agent or mortgage broker if you qualify for any incentives.
Areas with strong growth potential can also mean more wealth created over time, which can offset short term tax liabilities. A strong rental demand will help you achieve a stable income to service the loan.
Holding a property in your own name makes everything nice and simple, but it may not be the most tax-efficient structure.
Joint ownership with a spouse or family member can reduce your tax exposure, especially if they have a lower income than you.
You could also create a company or trust to own the property. This can have a number of benefits, especially when it comes to transfer of wealth to your kids or grandkids without having to pay some costly taxes. However, this route is complex and will you will need to get the right professional advice.
Many investors will opt for an interest only loan, at least for the first few years. This frees up cash flow and allows the rental income to take care of interest repayments. The interest is also the tax deductible portion of the loan.
Setting up an offset account can also be a tax-efficient way to reduce monthly interest costs as the balance in the account is subtracted from the loan balance when the lender calculates the interest you need to pay.
But one of the main benefits can be achieved through debt recycling. This is when you take the income you use from the investment to pay down non-deductible debt, such as the principal on your owner occupier home loan, which can then increase your tax deductions.
Long term tax planning
The longer you hold a property the greater your capital gain is likely to be, but there are ways to manage your exposure to CGT. If you hold it for more than 12 months, you will get a 50% discount on CGT. If you hold it forever and it pays itself off, you won’t need to pay CGT on it, because you’re not selling it.
If you think you are going to need to sell it, you can consider doing so in a year where you will have an otherwise low income.
If you’re one of the growing number of Aussies investing in property through a self-managed super fund (SMSF), you can hold your property until your SMSF pension phase begins and then tax won’t eat into your retirement funds.