Investment Properties + Their Tax Implications
Written by: Helen Yau l Accounting Team
Purchasing an investment property can be a very exciting time in your life and with record low-interest rates and a shortage of rental properties on the market, many are purchasing their first investment property often with the goal to build wealth. If you have recently purchased an investment property or are considering it, it may be worthwhile to consider the tax implications of purchasing and owning an investment property so that you can make an informed decision on all aspects of the process and go into your wealth-building journey with a clear understanding of the road ahead.
So before you go out and make a decision on which real estate agent you are going to use to find tenants to put into your investment property, or call your builder to help schedule in some renovations for the new bathroom you want to put in, it is important to have a chat to your accountant, like the team at Canny Group who are the accountants Geelong trusts with all aspects of wealth creation. This is to ensure that you understand the process, the depreciation schedules, the borrowing expenses, ownership structures as well as if there are going to be any capital gains tax implications to name a few. Making sure that you have your accountant working with you on your investment property journey is a great way to be able to hit the ground running so that you can focus on the fun side, the renovating, the decorating or just simply enjoying your hard-earned work in the shape of an investment property.
Financial Plan
Property Purchase
The initial costs of the purchase of the property are capital in nature and are not tax-deductible. This includes;
- Purchase Cost
- Legal +/or Conveyancing Fees
- Stamp Duty
These capital costs will form part of the purchase cost of the property in determining the capital gains tax on the sale of the property. It is important that you retain a copy of the contract of sale and settlement statement if and when the time comes to put this investment property back on the market at a later date.
Depreciation Schedule
Depreciation is the decline in value tax deduction for the building as well as the fixtures and fittings.
You may be able to claim depreciation on the building structure. If a property was built after 15 September 1987, you are able to claim 2.5% depreciation each year over 40 years. If the property was built before 1987, you may still be able to claim depreciation if there were any renovations that occurred after 1987.
You can only claim depreciation on the fixtures and fittings in the property if it is a newly built property and no one has previously claimed depreciation on it. A specialist quantity surveyor will be able to prepare a depreciation schedule for you that outlines in detail the amount you can claim as a tax deduction each year for up to 40 years. As a bonus, the cost of having the quantity surveyor prepare the depreciation schedule report is a once-off fee that is tax-deductible.
Financial Information
Rental Income
Rental income earned on the property will need to be included as taxable income when it is received. The following also need to be included as other rental income;
- Bond (if you are entitled to retain it)
- Insurance Payout for compensation of loss of rent
- Letting fee
- Reimbursement of deductible expenditure
Rental Expenses – Immediately Deductible
You can claim a tax deduction for property expenses only while the property is rented or available for rent. The expenses you can claim as an immediate tax deduction include:
- Advertising Fees
- Agent Fees
- Body Corporate Fees
- Building + Landlord Insurance
- Cleaning + Gardening Fees
- Council + Water Rates
- Interest on Loans
- Land Tax
- Repairs + Maintenance*
- Quantity Surveyor’s Fees for a Depreciation Schedule
*Repairs + Maintenance – certain repairs and maintenance expenses are capital in nature and are not deductible as repairs and maintenance. This may include replacement of the entire structure, improvements, renovations or extensions. Instead, you may be able to claim these expenses as capital works deduction which is generally 2.5%.
Borrowing Expenses
These are expenses incurred from taking out a loan or when you choose to refinance. Where borrowing expenses are more than $100, the borrowing expenses will be deductible over five years. Borrowing expenses typically include:
- Loan establishment fees
- Title search fees (charged by the lender)
- Costs for preparing and filing mortgage documents
- Mortgage broker fees
- Stamp Duty charged on the mortgage
- Fees for a valuation required for loan approval
- Lender’s mortgage insurance is billed to the borrower
New Assets – Depreciating Assets
Any new assets such as hot water systems, air conditioners or curtains that are greater than $300 will need to be depreciated over the effective life of the asset. Generally, the effective life of a depreciating asset is how long the asset can be used for. For most depreciating assets you can choose to work out the effective life yourself or to use an effective life that is determined by the Australian Taxation Office (ATO).
There are two methods for working out your tax deduction based on effective life, these are:
- Prime cost method
- Diminishing value method
The prime cost method gives you the same annual deduction for the asset’s effective life whereas the diminishing value method will give you a higher deduction in the earlier years. Most investors will choose the diminishing value to get the higher tax savings sooner.
Ownership Structure
There are several ways to structure ownership of the investment property. Whilst the simplest structure is owning an investment property in your individual name, you could also own the investment property in a company, family trust or a self-managed superannuation fund (SMSF). Each ownership structure has different tax implications and other structures may be more suitable and appropriate for you which is where your accountant can also be of great assistance.
Sale of an Investment Property + Capital Gains Tax
There may be a capital gains tax if you make a capital gain on the sale of the investment property. The capital gain will be included in your tax return in the financial year the contract of sale was signed, not the settlement date. If you have held the property for more than 12 months, you will be entitled to a 50% discount on the capital gain and only 50% of the capital gain will be included in your tax return and will also be taxed at marginal tax rates. Any costs of the sale of the property will reduce the capital gain and may include costs such as legal fees and advertising. You may be able to reduce the capital gain if the property was your principal place of residence during any time of the ownership period or if you make a personal tax-deductible contribution to your superannuation fund in the financial year the property was sold.
To find out more on Capital Gains Tax and if you need help to understand the tax you pay when it comes to selling assets and/or investments – check out this page!
Required Financial Records
It would be ideal to keep two separate files for each investment property you own!
One is a permanent file that should be retained for at least five years after the sale of the property and the other is an annual file for each financial year you own the property. The annual file should be kept for at least five years from the date of lodging your tax return.
Your permanent file should contain;
- Contract of Sale – Purchase and Sale
- Settlement Statements – Purchase and Sale
- Legal Fees – Purchase and Sale
- Agent Commission Statement – Sale
- Loan Agreement/s
- Depreciation Schedule
- Renovations and Improvements
Your annual file is the information that you would bring to your accountant each year and it should contain;
- Rental Statements
- Receipts and Invoices for all Property Expenses
- Loan Statements
Canny Group Taxation Services + Your Investment Property
We are here to help! If you are interested in buying an investment property or currently own an investment property and would like to know more about the tax consequences of owning an investment property, please get in touch with our Accounting Team so we can work with you on making the process as simple and easy as possible.
