How to save on tax by investing in property

One of the big perks of property investment is saving on tax, but everyone knows taxation is a complex beast.

So, how do you save?

Investors should claim depreciation; vary their “pay as you go” tax; carefully time any capital gain (to buy more time to pay the tax on it), and also keep up-to-date with the rules.

At least, that’s according to Rakesh Nairn. The chartered accountant at Brisbane-based BJT Financial Services shared with us his top tax tips for property investors, and you can read them below.

1. Claim depreciation, even after the fact

Like a new car, a property loses value with time, and investors can get a tax deduction for the yearly loss in value, Nairn explains.

“This is called depreciation and even older properties can still have some value left that can be claimed as a deduction,” he says.


What is tax depreciation?

Property depreciation is a tax break that allows investors to deduct their property’s decline in value from their tax bill. It extends to the depreciation of the building’s structure, items considered permanently fixed to the property, and plant and equipment assets found within it (think ovens, washing machines, carpets and blinds).

However, as you might have guessed, investors can’t claim deductions on all depreciating assets. The decline in value of second-hand assets can’t be claimed, for example, and some properties are exempt from the tax break, too.


How does it work?

Depreciation is claimed on an ongoing, annual basis, usually for the duration of the asset’s “effective life”.

If you owned or entered into a contract for a rental property before 7:30pm on 9 May 2017, you can claim deductions on the decline in value of the depreciating assets that were in the property before that date.

However, if you bought the investment property after that date, you can only claim depreciation on an asset if the asset was brand new, or the property was newly built or substantially renovated and no one had previously claimed any depreciation deductions on the asset.

If the asset costs less than $300, you can claim an immediate deduction. If not, you can calculate the deductions using one of two methods, both of which are broken down below. 


How do I calculate depreciation deductions?

If the asset is worth less than $300, then you should be able to claim an immediate deduction. If not, then you’ll need to claim the depreciation over a number of years, using one of the following two methods.


2. The diminishing value method

The first method is the diminishing value method. This is based on the assumption that the decline in value each income year is a constant percentage of the base value each year. Which means that the depreciation deduction on each asset becomes progressively smaller over the course of that asset’s lifespan.

This method uses the following equation to calculate an asset’s annual depreciation:

base value x no. of days asset was held in the income year/365 x 200%/asset’s effective life

In the income year the asset is first installed or used for a taxable purpose, the base value is equal to the asset’s cost. In later income years, it’s generally equal to the asset’s opening adjustable value for that year. And the ATO’s determination of an asset’s effective life can be found here

The ATO provides the following case study to explain this method:

“Laura purchased a photocopier on 1 July 2017 for $1,500 and she started using it that day. It has an effective life of five years. Laura chose to use the diminishing value method to work out the decline in value of the photocopier.

The decline in value for 2017–18 is $600, worked out as follows:

1,500 x 365/365 x 200%/5 = 1,500 x 40% = $600

If Laura used the photocopier wholly for taxable purposes in 2017–18, she is entitled to a deduction equal to the decline in value. The adjustable value of the asset on 30 June 2018 is $900. This is the cost of the asset ($1,500) less its decline in value to 30 June 2018 ($600).


3. The prime cost method

The second method is the prime cost method. This is based on the assumption that the value of a depreciating asset decreases constantly over its effective life, and therefore, produces a consistent decline in the item’s value over time.

This method uses the following equation to calculate an asset’s annual depreciation:

Asset’s cost x no. of days asset was held in the income year/365 x 100%/asset’s effective life

So, to use the above example, Laura would calculate her depreciation with this method in the following way:

1500 x 365/365 x 100%/5 = 1500 x 20% = $300.

The adjustable value of the asset at 30 June 2018 is $1,200. This is the cost of the asset ($1,500) less its decline in value to 30 June 2018 ($300).


Seek advice

The ATO’s rules on property depreciation are fairly complex, and so it’s recommended that you engage a quantity surveyor to create a tax depreciation schedule on your behalf. This will include information on what assets you can claim depreciation on, how much depreciation you can claim, and when you can claim it.

Nairn advises investors to ask BMT, one of the largest tax depreciation companies in Australia, to put together a depreciation schedule on their behalf. “Their fee will be far outweighed by the tax savings,” he says, adding that it’s also possible to claim depreciation for previous years.

“There’s a good chance you can still get a depreciation report done and amend your tax return for that year. You can only go back and amend two prior years.”


4. Claim borrowing expenses

Mortgage broker fees, lender’s mortgage insurance, loan establishment fees, and stamp duty charged on the mortgage are all tax-deductible expenses.

Here’s a full list of the borrowing expenses you can and can’t claim.

5. Consider applying for PAYG withholding variation

This trick allows you to pay less tax throughout the year – leaving you with more cash to service your regular interest payments.

What is a PAYG withholding variation?

A PAYG withholding variation is an application made to the ATO requesting to vary the amount of tax your employer must withhold from your salary each pay period. It allows you to receive your tax breaks each time you’re paid, rather than as a lump sum at the end of the financial year.

It’s advisable for property investors to apply for a PAYG withholding variation as their tax deductions are so big it’s hard for them to balance the books if they have to wait until the end of the year to receive them.

How does it work?

You need to apply for PAYG withholding variation every year, and can either submit this application to the ATO yourself or engage an accountant to do it on your behalf.

Once approved, the ATO tells your employer your new tax rate, which leads to an increase in your take-home pay.


6. Use negative gearing deductions

The current legislation on negative gearing allows investors to deduct any losses made on their investment properties from the tax they pay on their wages.

This means that if you pay more in loan repayments, maintenance and other relevant expenses than you earn in rent, you can deduct this shortfall from your income, so that you pay less tax.


6. Carefully time any capital gain

“If you’re looking to sell an investment property, resulting in a capital gain – meaning it is sold for more than you purchased it for – consider pushing this forward until July,” Nairn advises.

Why? July is the beginning of the new financial year, and so selling your property in July means you don’t have to pay the tax for a whole year. Be mindful, though, that the ATO considers the day the contract was signed as the purchase date, not the day cash passed hands.


7. Take advantage of the capital gains tax discount

Once you’ve sold your property, remember that you’re entitled to a discount on the capital gains tax you pay.

At the moment, this means that, if you’ve owned your property for more than 12 months, you’re eligible for a 50% discount on your capital gain.

Which means that if you make a capital gain of $100,000 from selling a property that you owned for more than 12 months, you would only add $50,000 to your taxable income.


Keep up-to-date with changes

Investors should know the rules and follow them, to avoid popping up on the tax office’s radar, Nairn says. For example, travel costs related to investment properties are no longer tax-deductible.

“The ATO is red-hot on rental property deductions,” says Nairn.

“For those using sites like Airbnb, who are considering not declaring the income, the ATO is one step ahead of you with their audit and data-matching activities.”