Capital gains and other taxes on investment properties
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Investment property tax
What is the tax on an investment property?
There are investment property tax benefits in some situations. If you are going to invest, it is important to understand the laws and regulations so you can maximise your returns. There may be implications for income tax, capital gains tax (CGT) and goods and services tax (GST) when you own an investment property.
John Liston, advisor and director at tax and accounting specialists, Liston Newton Advisory, says he’s seen plenty of clients scramble to find expense records come tax time. As a rule of thumb he advises clients to keep records of rental income and receipts for outgoing expenses such as any maintenance work done on the property.
“Enlisting the work of a plumber or electrician, any tradespeople that work on your property – make sure you are keeping receipts for all of those things and if a tenant has organised something themselves, make sure they know they need to ask for a receipt,” he says.
If you have an investment property that is not rented or available for rent – such as a holiday home or hobby farm, the property is subject to CGT in the same way as a rental property is, according to the ATO. However, you generally can’t claim income tax deductions for the costs of owning the property because it doesn’t generate rental income. (You may be able to include costs of ownership in the property’s cost base, which would reduce any capital gains tax liability when you sell it.)
Is an investment property tax deductible?
As the owner of an investment property, you can generally claim a tax deduction on related expenses while your property is rented or available for rent. You may be able to claim immediately (deducted against your current year’s taxable income) management and maintenance costs including interest on loans. Borrowing expenses, depreciation and capital works can be deducted over a number of income years.
Is stamp duty a tax deduction on an investment property?
There are some things you can’t claim on an investment property and one of them is stamp duty. That is, stamp duty on the title transfer. Stamp duty on the transfer of a property under the ACT’s leasehold system is generally deductible, according to the ATO website.
You should not factor in the expenses paid by your tenants as an investment property tax benefit. Things such as gas or electricity bills can not be deducted.
How much profit should you make on a rental property?
One way to make money through an investment property is through rental yield. At its most basic level, yield, while also being the fifth studio album by American alternative rock band Pearl Jam, is a measure of the rental income the property makes shown as a percentage of the property’s value. For example, a $500,000 property making $350 per week in rent equates to a rental yield of 3.6% ($350 x 52 / $500,000 x 100).
A property of the same value but with a rental income of $432 per week will have a yield of 4.5%. Higher yield means more income which in turn means a stronger cash flow position and more borrowing power for the next investment purchase.
How do I avoid paying capital gains tax on rental property?
While the sale of your family home – or main residence – is usually tax free, each time you sell an investment property you must pay Capital Gains Tax (CGT) on the transaction.
With rentals, the capital gains tax on the property applies on the date you sign the contract of sale. You must declare the profit or loss from the sale on your tax return in the same year as the sale took place.
How long do I need to live in a house to avoid capital gains tax?
While no one is exempt from CGT, you can manage your investment to minimise the amount you’ll need to pay. To minimise CGT, hold your investment property for at least 12 months. If you’ve owned the property for more than a year, you can apply a 50% CGT discount to your gross capital gain figure to calculate your net capital gains for your tax return. This means you’ll only pay CGT on half of the gross capital gain figure.
Let’s look at investor Eddie as an example. Eddie paid $250,000 for a property in Menai, Sydney, eight years ago. He also paid stamp duty and other costs amounting to $25,000. In 2017 he decides to sell this home for $500,000. What might the capital gains tax be on this property?
This creates a total cost base of $325,000. If we subtract $325,000 from $500,000 and calculate how much gross capital gain results from the sale, we get $175,000. Eddie adds this figure to his annual income on the tax return for the year of sale. This income is subject to tax in the same way Eddie’s other income is. If Eddie owned the property for over a year he could apply the 50% CGT discount and would only need to add $87,500 to the income declared on his tax return.
How does negative gearing work?
Negative gearing is when the running costs of your investment and any interest you’re paying surpasses the income you’re making on your investment. For example, if you’re charging $500 a week to your tenant in rent, but paying $600 on the mortgage repayments, you’re losing $100 a week.
The reason negative gearing is an attractive option for investors is because the net loss can be used as a tax deduction. You can also bank on the property increasing in value over time, meaning the loss in rental income will be cancelled out. If your property is positively geared, meaning you have a positive cash flow and are making more in rental return than you are in repayments, then you’ll be taxed on that gain.
What can you claim on your investment property?
Property investors can claim many of the costs associated with their rental property as investment property tax deductions according to the ATO, including:
Management and maintenance costs, such as:
- Advertising for tenants
- Body corporate fees and charges
- Council rates
- Water charges
- Land tax
- Gardening and lawn mowing
- Pest control
- Insurance (building, contents, public liability)
- Property agent’s fees and commission
- Repairs and maintenance
- Legal expenses such as the cost of evicting a non-paying tenant and expenses incurred in taking court action for loss of rental income.
Interest expenses, including the interest charged on the loan you used to:
- Purchase a rental property
- Purchase a depreciating asset for the rental property (for example, to purchase an air conditioner for the rental property)
- Make repairs to the rental property (for example, roof repairs due to storm damage)
- Finance renovations on the rental property, which is currently rented out, or which you intend to rent out (for example, to add a deck to the rear of the rental property)
- Purchase land on which to build a rental property.
Is landlord insurance tax deductible?
Landlord insurance covers you for tenant-related risks such as loss of rental income and damage by tenants to your property and contents. It is generally seen as an acceptable investment property tax deduction.
Is an apartment building a good investment?
You may have heard that buying a house is generally a safer buy than an apartment. This is because land is an appreciating asset and will always be in demand, whereas apartment blocks can be stacked next to each other, which can often lead to oversupply and drive values down. But that’s not to say an apartment isn’t a good investment. Do your research and find good areas to invest in and, depending on the area, an apartment could bring great rental yield, or capital gains – or both.
It’s worth enlisting the help of a quantity surveyor to do an inspection straight after settlement and just prior to the tenant moving in. A quantity surveyor can estimate construction costs for depreciation purposes
What is a good price-to-rent ratio?
There is no set price to rent ratio that you should apply to the property you buy. It will depend on the area in which you buy. Higher yield does not necessarily mean a ‘better’ investment. Buying an apartment in the Sydney CBD for example is probably viewed as ‘safer’ and more ‘blue chip’ however yield is generally around the 3.5% mark. In contrast, Newcastle/Maitland area won’t have as much demand from renters, but the yield might be around 4-5%.
Rental yield can be a good indicator of supply and demand. A low yield can sometimes be a warning sign of oversupply in a suburb. Basically, rental yield can be driven down when there is an oversupply of available properties because landlords will reduce rental prices in a bid to ensure they have someone living in the property. Vice versa when there is a lot of demand for that type of property in a suburb and landlords can raise rental prices because they know tenants don’t have an abundance of choice.
Generally speaking, regional areas have a higher yield than a CBD, however on average capital growth is slower.