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Lord of the Manor

You may be considering buying property or have already sealed the deal. You should consider structure before investing as this has important consequences on your final tax position. Structures appropriate for property investment can include individual ownership, owned jointly, a family trust or a superannuation fund. Companies are generally not considered suitable for property investment because of the ineligibility for the 50% capital gains tax discount. Factors to consider when looking at structure include:

Establishment costs
Family characteristics such as age, income and dependants
Capital gains tax (CGT) when selling the investment
Negative gearing
Asset protection

Rental income paid by the tenant will be assessable income. Once the property is earning income, you are also allowed to offset against that income any expenditure incurred in earning that income. There are, however, special provisions which disallow an outright deduction for capital expenditure or expenditure of a private or domestic nature.

Outgoings or expenditure associated with the property purchased will be divided into two categories. Those of a capital nature (associated with the structure or have ongoing benefit) and general deductions which are “consumed” during the year.

Items of a capital nature will include the cost of the property, stamp duty, legal fees on purchase, costs of building and pest reports. These costs are generally not deductible as an expense at year end but will form part of the cost base in calculating any capital gain when you dispose of the property.

Depending on when the property was constructed you may be eligible for a “capital works deduction” which is the cost of construction written off over the useful life of the property. For residential properties, where construction commenced between 18 July 1985 and 15 September 1987, a deduction of 4% of the construction cost is allowable. For properties where construction commenced on 16 September 1987 and onwards, a deduction of 2.5% of the construction cost is allowable each year. It is often difficult to obtain the actual construction cost so a quantity surveyor is able to estimate the construction cost and give a written report of the capital works deduction and also the depreciation for any items of fixtures and fittings (such as carpet, curtains, blinds, hot water systems etc.) included in your property purchase which are eligible for higher depreciation rates. The cost of the report is an allowable tax deduction in the year paid.

Another “capital cost” is borrowing costs. While these are not deductible outright, they are deductible over 5 years or the term of the loan – whichever is the shorter period. Borrowing costs include loan establishment fees, mortgage protection insurance, legal fees and stamp duty associated with the mortgage, valuation and survey fees.

Interest on borrowing associated with the property purchase is often the major expense associated with most investment properties. Interest deductibility depends on the “purpose” of the loan rather than the security. For instance you may offer as security your main residence – but the purpose of the loan was to purchase the investment property. The interest on the loan will be deductible in the year paid.

Other costs that are deductible outright include agents commission, advertising, body corporate expenses, cleaning, council rates gardening/lawn mowing, insurance, land tax, sundry legal costs, pest control, stationery/phone/postage, repairs and maintenance and travel to inspect the property.

Depending on the structure that your property is purchased in, you may be able to offset any loss against other assessable income (for instance your salary from employment). This is generally known as the “negative gearing effect”. If you are making losses on your property investment each year, you are able to ask the Tax Office to reduce the amount of PAYG tax taken out of your wages each pay period by your employer.

It is always recommended that you consult with your tax advisor before making any property purchases.

Owned individually or jointly

effective for a taxpayers who have no adult children for income splitting
effective for a taxpayers who are on the top marginal tax rate and intend negative gearing and/or prepaying interest on loans at year-end
suitable where asset protection is not a primary concern.

Any capital gain on the sale of the property (held for more than 12 months) is eligible for the 50% capital gains tax discount and is shared with your spouse (where owned jointly).

Salary sacrificing rental property expenses can be highly effective in minimising tax.

Companies

Because companies are not eligible for the 50% CGT discount (where assets have been owned for more than 12 months), they are not recommended for investments that will be subject to CGT (such as property).

Family trust

Trusts offer asset protection
Trusts have the ability to distribute income to adult children
provide discretion in the distribution of income so as to reduce tax
the 50% CGT discount applies to assets held for more than 12 months.

A disadvantage of trusts is that negative gearing losses are “locked” in the trust so taxpayers are not able to get an immediate benefit from any such loss unless the loss can be offset against other income in the trust.

Superannuation fund

In a self-managed superannuation fund income is taxed at 15% and offers significant asset protection, however they are not able to borrow to finance investments. Withdrawals from the fund cannot be made until retirement age.

Patricia Bakker is a lecturer at Southern Cross University and is a qualified chartered accountant and registered tax agent. She also has her own accounting and taxation practice called Taxpresso in Robina on the Gold Coast.

Contact details: Patricia Bakker

Taxpresso Pty Ltd

1/492 Christine Avenue,

Robina QLD 4226

PO Box 840,

Burleigh Heads, QLD 4220

Ph 0755 788 778

1300 723 882

Mobile 0417 401089.

patricia@taxpresso.com.au

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