Changing gears in property

By GEOFF ZACH, Chartered Accountant & Registered Tax Agent NEGATIVE gearing is when expenses associated with an asset are greater than the income earned from the same asset. The loss is then offset against other income, such as wages and salaries, which reduces the amount of income tax payable. Assuming legitimate deductions are claimed and depreciation is accurately calculated, an investor is losing money on a rental property but the size of the loss is reduced by the impact of reduced taxes paid. Recently, increases in land tax, council rates and interest rates in addition to the costs of materials and labour for repairs have eaten into the yield of properties. Negative gearing has been a contentious subject amongst politicians and tax reform for decades. In the past, politicians have debated that negative gearing inflates property prices and in turn, if removed will improve housing affordability. The counter argument is a lengthy debate and is outside the scope of this article. As such, I will leave such a debate in the hands of a learned economist. In 1985 the Hawke/Keating Government disallowed negative gearing interest expenses on properties purchased after July 17, 1985. Expenses were only permissible against rental income and the left over interest costs could not be offset against other income. Although, it could be offset against property income in later years. Due to adverse Sydney house prices and claims of a slowdown in the construction of new dwellings, the government reversed its decision and restored the negative gearing rules in September 1987. It is noted, Capital Gains Tax was introduced in September 1985 and changes in claimable depreciation laws in 1985 could have exacerbated the perceived problems faced in the property market. Negative gearing is allowed in Australia, New Zealand and Sweden but is subject to a range of restrictions in US and the UK where rental losses cannot be used to offset labour income. The volume of negatively geared properties have been affected by changes in capital gains tax laws and changes in availability of finance products to investors and changes in interest rates. The Australian Prudential Regulation Authority (APRA) is the government authority that overseas banking and protects the financial wellbeing of the community. APRA have tightened lending restrictions limiting the ability for investors to have highly geared property. Moreover, tax losses are affected by changes in tax law that reduce allowable deductions on rental properties, including the inability to claim the purchase of second hand plant and equipment nor travel. A key driver of a property to be negatively geared is the debt compared with equity invested in the property. The higher the debt, the more likely the property will be negatively geared. This will form a part of your borrowing strategy, along with taking into account future purchases and providing a buffer to ensure that should things go pear-shape, you won’t be at the beckon call of the financier. Although, it must be noted, that there are less initial funds required by the investor should they wish to have it negatively geared making a property purchase more attainable. A common myth is an investor rents a property or allows the use of family members at a discounted market rate or for free, then the investor claims 100 per cent of expenses at full cost. Thus, receiving the tax benefits of negative gearing. It is best to consult with one of our accountants to confirm the allowable deductions and whether any tax adjustments are required in such a scenario. Whilst tax is a consideration, one should consider if they are willing to make a loss on the investment, they should then be rewarded with strong capital growth. Consider that capital gains may provide a discount on taxes, but also allow the impact of inflation and that typically given that the capital gain will incur in one financial year may push the taxpayer into a high marginal tax rate. Negative gearing and property investing is not for everyone. First, one must consider their risk profile and whether such a strategy would benefit them. Let’s consider these case studies; 1. The property was held for four tax years and incurred total losses of $18,427 however, received tax savings of $5439. Thus, after considering the tax savings, the investors had an accumulated tax loss of $12,989 or negative 3 per cent. The capital gain excluding adjustments was $206,433 and the capital gains tax on the property was $17,026. After considering capital gains tax and rental losses, the investors made 45 per cent or 11.25 per cent per annum. 2. The property had a net rental loss of $75,049 and saved the investor $22,651 in taxes. Thus, after tax consideration, an accumulated loss of $52,398 over five tax years. The property has grown $84,000 but has not been sold. Thus, the investor has an approximate return of 1.7 per cent per annum before considering any capital gains tax. I query, would the investor had a better result if she invested her funds into a more conservative investment with safer returns, for example a term deposit? Per the RBA, the average advertised term deposit rate in the same period was 1.55 per cent. After considering tax, her return would have been one per cent per annum. When entering the property market, you should consider what structure is best to hold your new purchase. For example, should it be your Super, a Family Trust or another entity. It is best to discuss your options with Belmores Chartered Accountants & Wealth prior to purchasing. The Australian Taxation Office have advised that it will be focusing on rental deductions. Please make an appointment with one of our qualified accountants to review whether your deductions on your rental property are allowable.

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