Friday, November 26, 2010

The Taxing Points of Investing in Property

By Tim Olynyk. Prior to making a decision to invest in property, it is important to consider the tax implications of the investment…what will be assessable, what will be deductible and when the taxing points will arise.

Detailed below is a summary of some of the key points to consider:

Cost of Acquiring the Property

Costs associated with the acquisition of the property will not be immediately deductible and will instead form part of the tax cost base of the property for capital gains tax (CGT) purposes. Acquisition costs will include (but are not limited to) the actual cost of purchasing the property, stamp duty paid to acquire the property, conveyancing costs incurred to acquire the property and any advocates fees incurred to assist in finding the property. These costs will reduce the overall capital gain on the ultimate sale of the property in the future.

Deductible Expenditure

Provided the property is rented out or is actively marketed as available for rent, many ongoing costs incurred will be immediately deductible.

Some of the many costs that a landlord will typically incur that are immediately deductible include:

  • Costs of advertising for tenants
  • Body Corporate fees
  • Council rates
  • Water, electricity & gas
  • Insurance
  • Interest on loans
  • Land tax
  • Repairs & Maintenance (to the extent to which they do not represent capital improvements)
  • Quantity Surveyors fees
  • Agents fees

Negative Gearing

Negative gearing is the process whereby interest deductions and other deductions exceed the income derived from the property in a particular year. The net loss from the investment property can then be applied against other assessable income of the taxpayer (say income from employment) to reduce the amount of tax payable on the other assessable income. For example, for an individual investor on the top marginal tax rate, for every $1 of loss incurred on the investment property in a financial year, the taxpayer will save 46.5 cents of tax which would otherwise be payable on their other income.

Depreciation and Capital Allowance claims

On acquiring the property, the purchaser may be eligible to claim depreciation deductions and capital works deductions on some of the purchase price paid. To substantiate any claims made, a Quantity Surveyors Report should firstly be obtained which identifies the value of existing depreciable plant & equipment in the property and the value of eligible capital works expenditure. Thereafter, the owner of the property will be required to capitalise and depreciate any further plant and equipment they purchase while holding the property. Plant and equipment would constitute capital items such as carpet, hot water units, TV antennas, curtains, cook-tops and dishwashers. Each year, the Australian Taxation Office releases a tax ruling with the effective lives of various items of plant & equipment typically used in rental properties. The effective life of the particular items of plant and equipment will determine the rate of depreciation that can be applied to the asset.

Cost of disposing of the Property

Similar to the treatment of costs incurred to acquire the property, the costs incurred in the process of selling the property will also not be immediately deductible but will be eligible to form part of the tax cost base of the property for CGT purposes. Costs of selling the property could include real estate agents fees, conveyancing costs and marketing costs.

Capital Gains Tax

Generally, the taxing point for the sale of the property will arise when the contract of sale is executed rather than when settlement occurs. Thus if for example, the contract is executed in June 2010 but settlement occurs in September 2010, the capital gain will be required to be recognized in the 2010 financial year rather than the 2011 financial year. CGT is calculated on the extent to which the capital proceeds received on disposal of the property exceed the tax cost base of the property. Where the property is held in the name of an individual or a trust, a 50% CGT discount concession will be available where the asset has been held for more than 12 months. The net capital gain will then be included in the ordinary income of the taxpayer and will be assessed at the taxpayer’s marginal rates. If the property is held in a company, no CGT concession is available and the company will be taxed on the full amount of the capital gain at the corporate tax rate of 30%.

An example of the calculation of CGT payable on the sale of an investment property that has been held by an individual for more than 12 months that sells for $700,000 with a tax cost base of $480,000 (inclusive of stamp duty on acquisition of $30,000, agents fees on sale of $10,000 and marketing costs on sale of $4,000) is as follows:

Proceeds $700,000
Less Tax Cost Base ($480,000)
Gross Capital Gain $220,000
Less 50% discount ($110,000)
Net Capital Gain $110,000

Tax (@46.5%) $51,150 (assumes the top marginal tax rate applies)

Tim Olynyk is a Partner at Banks Group advising High Net Worth Individuals, family groups and privately owned structures advice on income tax, Capital Gains Tax, FBT, GST and Superannuation. You can read more of Tim's articles under Accounting and Taxation.

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