There’s a shortfall between the income said property generates and the costs it incurs. The investor’s accounts show being out of pocket as their income doesn’t cover costs, yet they don’t seem stressed about it. In fact, come tax time, they seem particularly relaxed. Why?
Tax evasion. Just kidding. The answer is much more legal: depreciation.
First, some basics to cover. A positively geared property is one that makes money after the costs of owning and managing it are taken into account. For a property to be negatively geared, the opposite occurs. It seems pretty cut and dry: negative = bad, positive = good. But that’s not always the case—which leads us back to that magic word: depreciation.
If you’ve ever purchased a new car, ‘magic’ mightn’t be the word you’d pick to describe depreciation. But when it comes to property, the value you lose once you get the keys can make its way back to you via your tax return.
Because depreciation of property is an ongoing paper loss calculated by a formula, it is not money you are actually spending on the property. But come tax time, it still counts as an expense that is added to what you have actually spent on holding the property throughout the tax year. The upshot is that as your total expenses increase, so too do your tax deductions, followed by your tax refund.
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In fact, you can be earning more from rent on a property than the day-to-day expenses of owning a property (including mortgage repayments) and still end up being negatively geared which can lead to a tax refund because of the deprecation expense.
So where do you sign? Before you put your plan into negative gear, it’s important to note that an investment property’s yield will always fluctuate according to interest rates, market rents, vacancy rates and expenses. Still, claiming for depreciation every year you hold your property is much easier than it might seem.
Depreciation is calculated off the construction cost of a building and the values of the included assets, as determined by a quantity surveyor who completes a depreciation schedule. Before you hightail it to Bunnings for some Hi-Vis and a hardhat, individuals are not qualified to estimate the construction costs or value assets in a depreciation schedule, and neither is your close family friend who’s also an accountant…for obvious reasons.
Calculating the annual deductions you can claim for the anticipated loss of value as your property gradually ages and approaches the end of its natural lifespan (up to 40 years), a depreciation schedule is your accountants best friend come tax time. Let’s say you purchased a new investment unit for $800K and the cost of building it was $500K, with the ATO’s notional figure calculated over 40 years, you could claim $12,500 a year on the structural element alone.
So, what’s the catch? Unfortunately, there could be one come sale time. When you’re ready to offload the property, the depreciation claimed is effectively added to the capital gains amount on which you will be taxed. But that’s a whole other article for another time. For now, sleep sound knowing that your negatively geared property can still generate cash flow through depreciation, giving you the benefit of having money to spend right now, rather than waiting for it at the end of your investment. Way better option than tax evasion (and, again, much more legal.)
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If you’re a keen to tap into extra equity in your property or a homebuyer who wants to explore what options are available to you – whether that be upgrading your home or buying an investment property – book in a call to discuss your borrowing capacity. We’d love to run through it with you.
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