FocusOn - Investment Properties

Property is a popular investment choice for many taxpayers.  There are a number of issues that you need to be aware of in order to maximise the taxation benefits of holding an investment property.

Impact on your tax return

You are required to include all rental income in your income tax return.  You can also claim a deduction for rental-related expenses.  If the rental income exceeds the allowable deductions, the property investment is positively geared and you will pay tax on the difference at your applicable marginal tax rate.

If the allowable deductions exceed the rental income, the property is negatively geared and the balance of the expenses can be claimed against your other income such as salary.  The Taxation Office allows you to claim negative gearing on the assumption that eventually properties will become positively geared and the excess income will become taxable.

The sale of an investment property acquired after the commencement of capital gains tax in September 1985 will be subject to tax based on the growth in value of the property.  The capital gain is included in your income tax return and taxed at your applicable marginal rate.

Deductions can be claimed from such time as the property is made available for rent.

Ownership Structure

When purchasing an investment property it is important to consider the ownership structure that best suits your needs.

If a property is negatively geared, you may wish to consider purchasing the property in the name of the primary income earner.  This will give you the greatest tax saving from the ongoing rental deductions.  However, this means that higher capital gains tax will be paid on the sale of the property.

Investing in the name of the secondary income earner is of benefit when the property is positively geared or when the value of the capital gain over the ownership period is expected to exceed the tax claims on a yearly basis, in which case access to lower marginal tax rates may be preferable.

If a property is purchased in joint names the rental income and expenses is split on a 50/50 basis regardless of actual incomes or the funds contributed by each owner.  In order for income and expenses to be split on any other basis, the property must be purchased as tenants in common.  This requires a specific legal agreement to be drawn up at the time of sale to specify each owner’s share of the property.

Interest

You can claim a deduction for the interest incurred on funds borrowed to acquire an investment property.  This includes funds borrowed for the purchase price of the property and any associated costs such as stamp duty and legal fees.

For deductibility of interest the important factor is what the underlying funds were used for, regardless of what the security was.  If you take out a second loan on your main residence to fund the deposit for an investment property, the interest on those funds is tax deductible.  If however, you drew down funds on your investment property loan to pay for a holiday or renovations to your main residence, that interest would not be deductible as the funds were not used for income-producing purposes.

Any funds withdrawn from an investment-related loan for private use will create a non-deductible portion of the loan that cannot be reversed without paying off the loan in its entirety.  It is important that you do not contaminate investment loans with private withdrawals.  This includes borrowing structures whereby you deposit your salary into the investment account and then withdraw funds at the end of the month to pay living costs.  If you are planning on an investment loan with an offset account, you should ensure that the offset funds are held in a separate linked savings account.

Other Expenses

You can claim a deduction for other expenses incurred in relation to an investment property such as property manager’s fees, body corporate, repairs and rates.

Depreciation and Capital Works

Renovations and building works are claimed at a rate of 2.5% per year.  If the building is less than 40 years old you may be entitled to claim a deduction for the portion of the actual cost of the building.  If the actual costs are not known, a quantity surveyor can provide you with a report to enable you to make this claim.  The cost of this report is tax deductible.

Replacement of fixtures and fittings such as carpet, air conditioners and curtains may need to be claimed over a number of years.  You can make an estimate of the value of fixtures and fittings included in the purchase and claim depreciation accordingly.  If you are obtaining a quantity surveyor’s report they will estimate these values for you.

Centrelink & Family Assistance

Negative gearing losses will not reduce your income for the purposes of Centrelink and Family Assistance benefits.

Estate Planning

When undertaking a major investment such as this it is important to review your Will to ensure that it is still valid.

A property purchased in joint names will not form part of your Estate.  Instead, your share automatically transfers to the other owner.

If a property is held as tenants in common, your share of the property is transferred to your Estate and dealt with in accordance with the provisions in your Will.

Published : May 2010