How to minimise tax with property
Using property to reduce your tax liabilities seems too good to be true, right? However, there are some great simple (and legal) ways to make tax work for you and your circumstances. Australia has many advantageous regulations for property investors, which span from the initial investment process, through to ownership and sale of the property. So, how exactly can you use property to maximise tax benefits and improve your financial situation?
When buying a property
One of the most popular methods of reducing your income tax in Australia is to buy an investment property and take advantage of a process called negative gearing. Negative gearing is a form of leverage which can offer investors certain tax benefits if the cost of the investment exceeds the income it produces. Essentially, whilst you make a loss on the property, that loss can be used to reduce the tax on your other earnings.
Negative gearing seems to go against your first instinct – after all, it relies on you to be making a loss on your investment. This loss occurs when the costs of maintaining an investment (for example, from loan repayments or renovation costs) are greater than the income you receive from it. Negative gearing is the process of leveraging this loss to offset the other income you earn, allowing you to pay less tax.
A (simplified) example:
Sarah buys an investment property for $500k. She then pays $50k in interest on the loan used to buy the property. She only receives $25k in rental income that year, therefore makes a total loss of $25k on that investment for the year. As a result, she can deduct $25k from her taxable income for the same year.
Of course, negative gearing is a risky process, and as with any tax or investment strategy, comes with its own set of supporters and opponents. In the end, the strategy’s success depends on the investment property itself.
When you own the property
Let’s say that you already own a property, and are looking to help offset your taxable income. This is the time to look for deductions that you can claim against your property. Some of the major costs to claim against your property include:
- Tenancy Related Costs – Advertising for tenants, leasing fees to property managers – anything related to preparing your lease is tax deductible!
- Repairs/Maintenance – Any new issues that didn’t exist when you bought the property that can be attributed to tenant wear and tear can be claimed.
- Holding Costs – Any money that goes into owning a property (body corp fees, cleaning, gardening, insurance, security, pests, property manager fees) are all tax-deductible straight away.
- Interest – Deduct interest your paying on your loan that you used to purchase a rental investment property (which also includes any borrowed money for tenant related issues).
When selling the property
Firstly, we’re going to mention CGT (capital gains tax) a lot – so, for those of you who aren’t familiar:
capital gains tax = a tax levied on profit from the sale of property or an investment.
Selling your property for a profit means that you make a capital gain, which will be added to your income and can significantly increase the tax you need to pay. So, whilst it may seems like you make a large profit from selling your property, the tax you need to pay on the capital gain can quickly reduce the overall amount of money you will be left with.
Thankfully, there are some strategies you can use to minimise CGT when selling your investment property. Our top tips include:
- Keep your property for 12 months or longer – doing so entitles individuals to a 50% discount of CGT, or a 33% discount for super funds.
- Align with your personal income – CGT is added to your income tax, so if you can time the two, it can really pay off! If you’re having a low income year, try to sell the investment property before the end of the tax year – think about aligning with years where you may have had extended periods of leave, or unpaid periods between jobs that could help decrease your personal income.
- Consider putting part, if not all, of your sales profits into your own super account. It’s just like salary sacrificing, which means you won’t be taxed as much.
- Got two properties? Maybe one is in Sydney, looking like it will generate a profit, whilst the one is in Toowoomba, looking to generate a loss – sell them at the same time! The loss of the Toowoomba property and the profit from the Sydney property in the same year will reduce the overall tax rate, and may finish you in a much better financial position than if you did them separately.
What is the 6 year rule, and does it apply to you?
When you first purchase a house, it can be established as either a main residence or a rental investment. Whatever you choose, that will dictate how the capital gain is calculated on sale at a profit. If main residence chosen, it will be exempt from capital gains tax for that time.
Under the 6 year rule, a property can continue to be exempt from CGT if sold within six years of being rented out (as long as no other property is nominated in your name as the main residence in this time). Where a property has great capital growth potential and your personal circumstances allow it, you can extend the 6 years by reoccupying the property at regular intervals (as the 6 years resets every time you reside in the property).
If you’d like to get some individual advice about how to maximise your tax benefits through property investment, we’d love to help! Please get in touch with us at firstname.lastname@example.org, or fill out this contact form and we will get back to you.