What types of investment property tax apply?
There are two types of investment property tax that apply to investment properties that owners should be aware of. These two include capital gains tax (CGT) and income tax concerning your rental property.
In this article, we go through exactly what the implications of these taxes are and what you should know when making key decisions in your investment property.
Income & Expense Recordkeeping for Investment Property Tax
Throughout my experience working with clients, it often happens that they fail to keep accurate or any record of investment property income or expenses. Just like preparations for your personal tax return, it’s imperative that you are keeping receipts and rental income statements for your property in order to accurately assess your tax situation. Besides keeping your annual rental income statement, below is a list of expenses that can be generated from your investment property:
- Council Rates
- Body Corporate Fees & Charges
- Water Charges
- Land Tax
- Cleaning & Gardening Costs
- Pest Control
- Insurance (building, contents, public liability, landlord)
- Property Agent Management Fees
- Repair Costs
- Legal Costs that result in loss of rental income or court action
- Interest on the loan of the property or to improve the property
- Purchases on assets for the rental property
- Renovation Costs
If you are missing any of these or need to attain copies of these documents, it would be wise to find as many of these before tax time as you can.
Tax #1: Capital Gains Tax on Your Investment Property
It’s important to note that the sale of your primary residence, that is your family home, is usually tax-free and will not attract Capital Gains Tax (CGT) on the transaction of the sale. However, each time an investment property is sold, Capital Gains Tax (CGT) must be paid.
The date in which CGT applies is on the date of the contract of sale, not the date of settlement.
Whilst you cannot avoid Capital Gains Tax (CGT), property owners are eligible for a 50% CGT discount on their gross capital gain figure if the investment property has been held for at least 12 months.
How is Capital Gains Tax Calculated for your Investment Property?
To calculate a capital gain (or loss), you must know the cost base of your property. This refers to the cost of the property when you purchased it, plus other costs associated with acquiring, holding and disposing of the asset.
For example, Charlie paid for a property in 2011 for $300,000 in Melbourne and has decided to sell his investment property in 2019 for $600,000. During this period, he also incurred costs such as repairs, council rates and legal fees that amounted to $50,000. Therefore, this creates a total cost base of $350,000.
To calculate how much capital gain (or loss) has resulted in the sale:
Final Sale Price – Cost Base = Gross Capital Gain
$600,000 – $350,000 = $250,000
As Charlie has owned the property for more than 12 months, he, therefore, is eligible to apply the 50% CGT discount. This is then added to his annual income on his tax return for the year.
Note: If you have made a capital loss, this loss is assessed separately to income and cannot be used to offset personal income you’ve earned throughout the year. Instead, this will be rolled over each financial year to reduce future capital gains.
What If I Don’t Rent It Out? Can I Claim The Expenses as a Tax Deduction?
Generally, you cannot claim income tax deductions for the costs of owning the property if it doesn’t generate rental income. The property is still subject to CGT in the same way as a rental property, however, you may be able to include the costs associated with ownership of the property to the cost base. This will assist in reducing any capital gains tax liability when you sell it.
Tax #2: Rental Income & Investment Property Tax
The majority of residential investment properties are rented out. As it’s a form of income, you must declare it when lodging your tax return. For the sake of clarity, rental income is any form of payment you receive for the use or occupation of your property. This can include security deposits, insurance payouts, reimbursements, advance rent or payments for cancelling a lease.
What Deductions Can I Claim on My Rental Property?
See the above list of expenses that can be claimed.
As mentioned, maintaining healthy records relating to your property’s rental activities is incredibly important to accurately assess your taxable income or loss.
How Does Rental Income Affect My Investment Property Tax Liability?
Your rental income is essentially treated as another form of income (hence the name – income). As such, your rental income will be combined with your personal income at the end of each financial year and will be assessed together.
This is also applicable in cases where you’ve made a loss where your expenses for the property have outstripped the income you’ve generated from it. This is also known as negative gearing. This loss will offset your income and result in you more than likely to receive a tax refund depending on the level of personal income and tax you may have received and paid during that financial year.
What If I’m a Property Developer or Builder? Does this apply to me?
No, this does not apply. It is best that you speak to an accountant or tax specialist to understand how the tax is applied in your case. More than likely you would be considered a business in property development or building.
You can see that factoring in the tax implications on your investment property decision-making can potentially save you a lot of money. It helps a lot to consider both the capabilities of the property to generate a positive rental yield as well as when you may expect to sell the property, as well as the market conditions at the time. A lot of this may be uncertain and difficult to forecast exact numbers and growth rates, but knowing a ball-park figure based on market data can put you in a more favourable position to capitalise.
It’s important to remember that this advice is general in nature and everyone’s situation is different. Therefore, it’s highly recommended that you speak to an accountant or a tax agent to assess your personal situation on its merits. If in doubt, you can book a free 45-minute consultation with Box Advisory Services to find out whether or not you’re on the right track.
Until next time!
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Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to contractors and small businesses. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek your own advice for any legal or tax issues raised in your business affairs.