How are you Taxed on your Investment Property?

Allowable deductions

Expenses or outgoings that are incurred in the course of producing assessable income or carrying on business, to the extent that it is not capital, private, or domestic in nature. Common allowable deductions include council rates, interest on a bank loan drawn down to buy an investment property, land tax, etc.

Assessable income

Income derived on your investment property, which is predominantly rent and, in commercial properties, recovery of outgoings pursuant to the lease. Other assessable income includes non-recurring receipts, such as insurance recoveries.

Capital gain

The amount by which the capital proceeds on the sale of an investment property exceed the cost base of the property.

Capital gains tax (CGT)

The tax liability on the growth in value of an investment property over time, from when it is acquired until that value is realised (ie when the property is sold). The net capital gain in a given year is included in assessable income, which in turn forms part of taxable income on which the applicable tax rate is applied to calculate the tax liability.

Capital loss

The amount by which the reduced cost base of an investment property exceeds the capital proceeds on the sale of the property.

Capital proceeds

The proceeds received from the sale of an investment property. However, in some circumstances – for example, if the sale of the property to a related party is not an arm’s length transaction – the ‘market value substitution rule’ will apply, in which case the capital proceeds will be deemed as the market value of the property, rather than the actual sale price.

Capital works deduction

Also known as ‘building allowance’, which is the allowable deduction for depreciation on buildings and structural improvements that are attached to land.

Cash flow negative

The arrangement under which the cash expenses and outgoings incurred on an investment property exceed the cash income derived on the property.

Cash flow neutral

The arrangement under which the cash income derived on an investment property equates to the cash expenses and outgoings incurred on the property.

Cash flow positive

The arrangement under which the cash income derived on an investment property exceeds the cash expenses and outgoings incurred on the property.

CGT discount

I will be discussing with you, your contracts and disclosures.

Cost base

The cost base of an investment property generally includes its purchase price, incidental costs on its purchase and sale (eg stamp duty, legal costs, etc), certain non-deductible holding costs if it was acquired on or after 21 August 1991, capital costs to increase or preserve the value of the property, and capital costs to preserve or defend your title or rights to the property. The cost base is also reduced by the cumulative capital works deductions claimed on the property if it was acquired after 13 May 1997.

Depreciation

Allowable deduction for the decline in value of depreciating assets, which are generally assets that are not attached to land, buildings, and improvements, ie freestanding assets that decline in value over time, such as stoves, dishwashers, carpets, curtains, etc.

Entity

From an income tax perspective, the most common entities include an individual, a company, a trust (which includes discretionary trusts and unit trusts), and a partnership. The tax law generally treats each entity as a separate taxpayer unless the entities, while not usually relevant to property investment, have formed a tax consolidated group.

Goods and services tax (GST)

Indirect tax imposed by the federal government, which is levied on suppliers for taxable supplies they provide, to the extent that the supplies are not input-taxed or GST-free.

GST-free supplies

Supplies provided by a GST-registered supplier in the course or furtherance of their enterprise connected with Australia under the GST law that is specifically treated as ‘GST-free’. If the supplier provides GST-free supplies, they are not liable for GST on the supplies but can generally claim back the GST on expenses incurred in providing the GST-free supplies. A common investment property example is the leasing of a residential property by a charity, where the actual rent charged is less than 75% of the market rent on the property.

Holding costs

The costs incurred in owning a property, eg interest on the loan is drawn down to purchase or refinance the property, along with repairs and maintenance costs, rates, land tax, etc. These costs are generally tax deductible if they are incurred in the course of deriving rental income from the property. If no tax deduction has been claimed on a particular cost, it may be included in the cost base of the property if the property was acquired on or after 21 August 1991.

Income tax

Direct tax on taxable income (which includes CGT) imposed by the federal government.

Income year

Also known as the ‘financial year’, which runs from 1 July to 30 June in Australia.

Input-taxed supplies

Supplies provided by a GST-registered supplier in the course or furtherance of their enterprise connected with Australia under the GST law that is specifically treated as ‘input-taxed’. If the supplier provides input-taxed supplies, they are not liable for GST on the supplies but cannot claim back the GST on expenses incurred in providing the input-taxed supplies. A common investment property example is the leasing and sale of a residential property.

Land tax

Indirect tax imposed on land holdings by the state and territory governments.

Limited recourse borrowing arrangement

A special borrowing arrangement under which a self-managed super fund (SMSF) may borrow from a third-party lender to buy an asset such as an investment property to be held in a separate trust. If the loan defaults, the lender's rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held by the SMSF.

Main residence exemption

The CGT exemption available on a property over a given period. Generally, a person or a married or de facto couple can only ever have a single main residence at any one time. If a property is only sheltered by the main residence exemption for part of its ownership period, an apportioned capital gain or capital loss may be crystallized if and when the property is sold.

Negative gearing

The arrangement under which a net tax loss is made when the total allowable deductions on an investment property (predominantly interest expenses) exceed the total assessable income derived from the property. The net tax loss is then used to reduce other assessable income of the owner (eg salary and wages), which has the effect of reducing the owner’s tax liability. A negative gearing arrangement can be cash flow positive, cash flow negative, or cash flow neutral.

Net capital gain

The sum of all capital gains derived and capital losses incurred in a given year. Any capital gain that is eligible for the CGT discount is first reduced by any current year, and/or carried forward as capital losses first before the CGT discount is applied.

Reduced cost base

The reduced cost base of an investment property is generally the same as the cost base, except for certain balancing charges that may need to be included. The reduced cost base is also reduced by the cumulative capital works deductions claimed on the property if it was acquired after 13 May 1997.

Self-managed super fund

A superannuation fund privately controlled and operated by an individual as opposed to the industry superannuation funds available to the general public.

Stamp duty

Indirect tax imposed on the transfer of assets by the state and territory governments, which includes what is commonly known as ‘land-rich duty’ or ‘landholder’s duty’ where land is involved.

Tax refund

The amount the ATO owes a taxpayer after a tax return has been processed and it has been assessed that the tax paid on the taxable income has exceeded the actual tax liability payable for the year. The overpaid tax is refunded to the taxpayer as a tax refund. A tax refund is not a ‘tax return’ or a ‘tax rebate’.

Tax return

The document a taxpayer needs to lodge annually with the ATO. A tax return is not a ‘tax refund’ or a ‘tax rebate’.

Taxable income

Assessable income, which includes net capital gain less allowable deductions. Depending on the entity involved, the taxable income amount is multiplied by the applicable tax rate to arrive at the tax liability of the entity.

Taxable supplies

Supplies provided by a GST-registered supplier in the course or furtherance of their enterprise connected with Australia to the extent that the supply is not input-taxed or GST-free. If the supplier provides taxable supplies, they are liable for GST on the supplies but can generally claim back the GST on expenses incurred in providing the taxable supplies. A common investment property example is the leasing and sale of a commercial property.

Temporary absence rule

A person who owns a property that is eligible for the main residence exemption may continue to treat the property as their main residence even if they have moved out, provided that they do not acquire another main residence elsewhere. If the property is rented out, the property can remain the person’s main residence for up to six years. If the property is not rented, it can remain the person’s main residence indefinitely.

Three words you need to know now

Deduction

Your best friend in reducing your taxable income, therefore reducing your tax liability.

Yield

Return on investment in a property. Understanding the relationship between yield and property value is crucial in making sound property investment decisions.

LVR

The LVR, or ‘loan-to-value ratio’, provides valuable information on how much equity is available in a property which could be used to invest in additional properties.

Five things accountants to look for in

Quality and timely service

in our rapidly changing world, accuracy and responsiveness are the key attributes of a good accountant.

Specialises in property

including a reasonable profile in the property industry, and can readily provide testimonies of clients who operate in the industry. Many ‘general practitioners’ may not have the expertise to deal with your property-specific issues.

Long-term trusted advisor

who knows every aspect of your financial (and personal) life. The history and understanding they gain over a long period of time will translate to more relevant, proactive and timely advice.

Wide range of services

(eg audit, business valuation, etc) all under one roof – otherwise you may find yourself having to deal with multiple advisors who may overlap in the services (and therefore costs) they provide to you.

Members of peak bodies such as the Institute of Chartered Accountants in Australia

The Taxation Institute of Australia, and/or the Society of Certified Practising Accountants. Members are required to undertake rigorous post-tertiary education to gain their professional qualifications and are also required to maintain a minimum number of continuing professional education hours each year to stay up to date with the latest developments.

Courtesy 'Your Investment Property' by Eddie Chung