A rental (investment) property is negatively geared when it is purchased with borrowed funds and the loan interest and other tax deductible costs related to the property exceeds the rental income. Negative gearing is considered as a tax planning tool as the losses incurred on a rental property can be offset against other assessable income.
Buying a negatively geared property means buying a loss making asset, the loss only gets compensated to some extent (depending on the investor’s marginal tax rate, discussed below) by the tax saving. As an Investor, you should aim to find a property that costs minimum to own and have long term capital growth potential. Tax saving should not be the main focus of buying an investment property.
Marginal Tax Rates
Amount of tax saving from a negatively geared property depends on the individual’s other assessable income and marginal tax rate. People in the top marginal tax rate (income exceeding $180,000) will have the maximum tax saving from a negatively geared property. For example for 2017/18 highest marginal rate of 45% (plus 2% Medicare Levy) applies to income exceeding $180,000. For, someone with other assessable income of $200,000 and renal loss of $10,000 amount of tax saving will be $4,700. If the same property is held by someone with other assessable income of $87000, the amount of tax saving will only be $3,450.
Income Tax Return with investment property
When you have an investment property, you will have to work out net income or loss from the property which will be added to your other assessable income.
Rental income is obviously the income of the property and below are the deductable expenses.
- Interest on mortgage (Usually interest before the property becoming income producing is also deductible)
- Depreciation (discussed below)
- Borrowing expenses (excluding interest) – You can claim a deduction for borrowing expenses associated with purchasing your property, such as loan establishment fees, title search fees, lender’s mortgage insurance, and costs of preparing and filing mortgage documents. If your total borrowing expenses are more than $100, the deduction is spread over five years or the term of the loan, whichever is less.
- Management and maintenance costs for the period the property is rented or available for rent.
Below are examples of some non-deductible expenses.
- Acquisition and disposal costs of the property
- Expenses not actually incurred, such as water or electricity usage charges borne by tenants
- Travel expenses to inspect a property before it is bought
It is very important to keep proper records of rental income and all management and maintenance expenses to make sure you don’t pay more tax than necessary.
A property for tax purpose is considered as having the building structure and various items of plants such as air conditioning units, stoves etc. Depreciation is deductible for decline in value of plants and capital allowance is deductible for building at 2.5% of construction expenditure that can be claimed.
Generally a depreciation schedule prepared by a licenced Quantity Surveyor is required in order to claim depreciation and capital allowance. It is worth paying few hundred dollars for the schedule as it helps to maximise allowable deductions. Further, these are the deductions which are available without incurring any annual cash expense.
Capital Gain Tax
When an investment property is sold there is usually a capital gain or capital loss. This is the difference between the cost and sale price. Capital Gains Tax is a tax charged on any capital gain arising from the sale of capital asset acquired after the 19th of August, 1985.
Capital gain is added to your other assessable income and total income is taxed at your marginal rate. Any capital loss cannot be offset against your normal income. It can be offset against a capital gain or can be carried forward to be offset against future capital gain.
It is important to keep records of all costs associated with purchase and sale of an investment property as these will be considered to work out your capital gain/loss. Dates of acquisition and sale are also very important to determine whether you have hold the property for more than one year