How to turn a negative property into a positive one

We often receive enquiries from potential new clients whose first investment property is costing them money.

Sometimes, it’s because they have unfortunately bought the wrong type of dwelling in an inferior location.

But, quite often, their property could be neutral or even positive cashflow if they just did one simple thing.

What I’m talking about is a depreciation schedule, which many investors still don’t understand nor do they utilise to their financial advantage.


What is a depreciation schedule?

According to our friends at MCG Quantity Surveyors, tax depreciation on a residential investment property is a deduction against assessable income that allows the owners to reduce the amount of tax payable.

The deduction is based on the depreciating value of the property asset with an investor able to claim for two distinct types of depreciation on buildings, which are capital allowance, and plant and equipment.

A tax depreciation report is prepared by a qualified quantity surveyor and generally outlines the depreciation that can be claimed in the property over the life of the building or about 40 years.

The schedule is then supplied to your tax accountant who includes the relevant years deductions in your tax return each year.

One of the main misconceptions about depreciation is that it’s not worth doing for properties that are older, which this is usually not the case.

This is mainly because depreciation came into effect in 1987 so investors often think that if their properties are older than that they will not qualify for any deductions.

The truth of the matter is that buildings constructed before 16 September 1987, which is the line in the sand date, have usually had some sort of renovations or improves that will qualify for deductions.

Indeed, according to MCG, about 64 per cent of properties built before 1987 had undergone improvements with the average improvement value being nearly $40,000, which would likely be tax deductible over time.


Turn that loss upside down

A friend of mine owns an art deco investment apartment that was built in 1939 but as a seasoned investor she knew the value of having a depreciation report prepared for it when it became an investment property.

Over the years she had owned it, the building had been repainted inside and out, plus had new cabinetry and air conditioners installed.

These improvements meant that there was actually $3,450 of depreciation on the property each year.

While it might not seem like much, it certainly can make the difference between a property being in negative, neutral, or positively geared territory.

Indeed, the yearly depreciation was the equivalent of the annual body corporate fees for the property.

We often talk about how important cash flow is for investors so they can hold their properties for the long-term and capital growth can grow.

However, it’s vital that you understand that cash flow happens at different times and in different ways.

Depreciation schedules are part of this cash flow equation because they can often result in investors receiving increased tax returns compared to if they hadn’t claimed depreciation on their properties at all.

These extra funds, which flow every year, potentially for decades, can then be considered as part of an investor’s cash flow pool.

Fundamentally, every dollar can make a big difference to your wealth creation plans, because it allows investors to retain their portfolios for the length of time needed for compounding capital growth to become a reality.

How to minimise land tax

One of the most common issues I see happen to investors who focus on buying in one location only is land tax.

This is especially so if that market has had a strong price growth period, so the values of their holdings increased significantly.

Perhaps at the start of the year they were under the threshold, but by the end they had tipped over and were now liable to pay the relevant State Government more of their hard-earned money.

The key is, of course, is that it doesn’t have to be that way.

In fact, I have yet to pay one cent of land tax in my own personal portfolio, and these are the reasons why.

Diversity is key

Like so many other elements of property ownership in Australia, land tax is state-based with each having different payment thresholds.

While that might seem a little painful because of the different value limits, in reality it is a situation that can be financially beneficial for investors.

You see, my portfolio is spread across a number of different states, where I have yet to hit the thresholds.

Ditto, with our clients, who invest in real estate in the best markets across the country.

Not only does that mean they’re making the most of market conditions in diverse locations, they also are able to keep under the relevant land tax considerations in each state.

Of course, it’s important to realise that land tax is based on the land value – not the purchase price of the property – so there are opportunities to buy a number of properties in one location without worrying too much about paying land tax.

Ownership diversity

As well as buying in diverse locations, investors can also opt to buy in different names.

For example, my personal portfolio has a mix of properties in my name and in my wife Sophie’s name, too.

That’s because land tax is based on an individual’s assets and taxation position.

By owning property in different names, within the legal limits of course, you can minimise land tax as well.

A statement I’m often initially told by our many clients aged between 20 and 40 is they want to “set up a trust”.

Usually they say it’s for “protection and taxation purposes” but they often misunderstand the positives and negatives of using trusts as an ownership structure for property.

Now that is a blog for another day, but in short, buying property in a trust may mean you have to pay land tax from day one as there is no threshold as such, plus there are significant costs involved in setting up and maintaining one to boot.

Another diversification option when it comes to land tax, however, could be dwelling type.

While I am currently recommending clients buy established houses because of the favourable market conditions in many locations, established townhouses or units could be an option for people with affordability constraints.

In fact, buying an affordable house with development potential could achieve the same purpose in the future now I think about it.

What I mean is that most buyers can’t afford a house in Coogee, for example, but they could purchase an established unit, plus those types of dwellings are always in strong demand from renters in that location as well.

At the end of the day, we all have to pay our fair share of tax during our working and investment lives.

While our contributions help support those less fortunate than ourselves, that doesn’t mean that investors can’t be strategic with their location selections that will improve their overall chances of capital growth – with a happy by-product being a slightly smaller hit to their back pockets in taxes.

 

State by state land tax information

Australian Capital Territory

New South Wales

Northern Territory

Queensland

South Australia

Tasmania

Western Australia

Victoria

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High-Performance Property Investment in 5 Simple Steps

In this free guide, you will learn how to Implement the same strategies that led me to build a $3.5 million dollar portfolio in less than six years. – Daniel Walsh