Hi guys. I just bought and read Steve's 0-130 properties book and am trying to further educate myself. Although I am probably a year or two away from having enough cash to do anything (renting at the moment) I am struggling with a few tax concepts. I'll lay out what I believe is the right way of interpreting tax involving IPs through an example; If you could help me by pointing out anything I miss or get wrong, that would be a great help.
- I find a unit for $230k with a current tenant renting at $275 a week.
- I can buy this place with a 80% LVR, putting down a $46k deposit. Interest is at 6.5% ($11,960 interest pa)
- Other expenses will include strata, water rates, council rates, insurance and maintenance which is around $4,500 pa
A quote from the ATO website:
Generally you can claim an immediate deduction for expenses related to the management and maintenance of the property, including interest on loans. You can claim a deduction for these expenses only if you actually incur them and they are not paid by the tenant.
If your property is negatively geared – that is, you borrowed money to buy the property and your net rental income after other expenses is less than the interest on the loan – you may be able to claim the full amount of rental expenses against your other income, such as salary and wages.
So I work out the following:
Rental income – expenses: 275*52-4500-11,960 = $-2,160
My property would be neg geared.
Tax Refunded (at 37c bracket): (4500+11,960)*0.37 = $6,090
Cashflow = -2160+6090 = $3,930
My questions:
What is the difference between claiming a deduction on all my interest and expenses (the first paragraph) and claiming the full amount of rental expenses against other incomes if negatively geared (second paragraph)? Although not clear, do the expense deductions only apply to the rental income if positively geared. thus only a small percentage of the expenses will be deducted?
If so, does that mean it is always best to be negatively geared (but only just) so you can claim the full amount of expenses against a larger income and maintain a higher positive cash flow (if this was the purpose)?
Also, I feel I have left out a tax component. Since rental income must be declared, when does this get taxed? After a property has been determined to be neg geared? Before? Is my overall cash flow ($3,930) taxed at the 37c bracket?
Perhaps the questions are pretty technical for someone who doesn't even have a deposit or equity to work with but I have a head for numbers and its all I can work with for now.
Thanks!
So I work out the following:
Rental income – expenses: 275*52-4500-11,960 = $-2,160 ????? Where did you get $2,160???
My property would be neg geared.
Tax Refunded (at 37c bracket): (4500+11,960)*0.37 = $6,090 You are adding income to costs here???
Cashflow = -2160+6090 = $3,930 No!!!
How you work it out.
In- Rent $4500 – (costs- interest, insurance, rates, maintenance, strata fees etc) say $15,000. So you are negatively geared $10,500 @ 37% = $3885 (tax back). So it will cost you $6615 a year to hold. If you have depreciation you add this to the $10,500. So if you have $3000 depreciation (for example) you will only be out of pocket $5505pa.
If your rent is more than all your costs you are positively geared and you'll pay tax on that.
Hi Patted,
The tax process is pretty simple really.
Assume the property runs at a loss (negatively geared)
Assume you earn $80K
Your Rental income is $10K/annum
Your rental expenses are $20K/annum
Taxable income is now 80K + 10K – 20K = 70K
You will then be taxed as if you are earning $70K and not $80K
Assume the property makes a profit (positively geared)
Assume you earn – $80K
Your rental income = $20K
Your rental expenses = $10K
Taxable income is now $80K + $20K – $10K = $90K
The ATO will calculate how much tax you should have paid over the course of the financial year when they receive your tax return. If you have paid too much you get a refund. If you haven't paid enough you'll get a bill.
Personally I don't have a problem buying a property that is slightly negative cashflow. Make sure the reason you buy the property is to make a profit in the long term Too many negatively geared properties and you will find yourself with reduced overall cash flow and additional borrowings will be restricted.
Hope this helps
Thanks for the reply.
You seem confused on my working, so I'll elaborate it a bit more.
Rent per annum = 275*52 = $14,300
Interest per annum = $11,960
Other costs per annum = $4,500
Cash flow before tax = 14,300-11,960-4500 = -$2160 (so this is my loss before applying tax deductions).
Based on your working, it seems I only apply the tax deduction to the amount lost ($2160), not the full expenses ($11,960 + $4,500).
Tax Refunded (at 37c bracket) = Neg geared amount * tax bracket = (2160)*0.37 = $799
Which makes the cost to hold $1361 per year (and makes me sad because I thought I had a positive cashflow before!).
In that case, why does the ATO website bother saying everything from agent fees to repairs and interest on borrowings can be claimed on tax? The only thing we have claimed here is the lost portion of these expenses.
I've also read about making positive cash flow from a negatively geared property. Is this actually possible?
Thanks Derek, that seems a very simple way to think about it.
I think I need to do more research on positive cash flow properties. I can understand that you want to make gains on capital which can outdo the negative gearing loss each year. But what if the purpose is to have positive cash flow? Can this be achieved on a slightly negative geared property, after tax deduction on expenses are made? I thought I had read a book that said yes but maybe I had rose tinted glasses on.
Edit: I went back to the books and found that its only "on paper" losses (through depreciation of fixtures) that can swing the negatively geared property to have a positive cashflow. Probably not likely for me with a low tax bracket and low investment options to begin with.
In that case, why does the ATO website bother saying everything from agent fees to repairs and interest on borrowings can be claimed on tax? The only thing we have claimed here is the lost portion of these expenses.
Sorry for the confusion. I didn't calculate the rent. You do claim those other things too. You add them to your expenses.
So rent- ALL expenses gives you and amount + or – That is what is added to you wage to calculate tax.
Yes you may be + on paper after you add in depreciation.
It's a lot to get your head around. Keep reading. You'll get there. Lots of people are looking for + CF. It depends on your strategy. Some people prefer -CF as they get the tax benefits and beieve that those properties have highher capital growth.
I like +CF and CG. I'm greedy. LOL
patted03 wrote:Probably not likely for me with a low tax bracket and low investment options to begin with.Negatively gearing is a strategy more suited to higher income earners for two reasons; they generally have higher disposable income to support the shortfall and secondly they are taxed at a higher rate and therefore any deductions they get will have a more pronounced effect on their tax refund.
Wow….patted you've made something quite simple seem really confusing.
I'm only new to property investing so please excuse me if I am wrong but this is my initial thought to what is spoken above.
When you guys are talking about getting tax back after all expenses every year to bring you into the positive in your bank account, doesn't this mean it's positive gearing and not positive cash flow?
Regards,
Matt Horne.
Basically as Derek put it, a negatively geared property will reduce you taxable income at the end of the financial year, and a positively geared property will increase your taxable income at the end of the year.
The total loss or gain is not actually how much tax you will get back or have to pay. That all depends on what tax bracket you are under and is calculated using that.
You could theoretically have a negatively geared property, but still have to pay tax at the end of the year and vice versa depending on what you have done during the year.
Cheers
Tom
Yes I did. So far my tax has involved putting down my income and my youth allowance while at Uni. I'm glad there are helpful members here that have cleared up my misconceptions.
matthewhorne wrote:When you guys are talking about getting tax back after all expenses every year to bring you into the positive in your bank account, doesn't this mean it's positive gearing and not positive cash flow?
Regards,
Matt Horne.
Yes that is correct. Positive gearing is taking tax advantages into account.
Positive cashflow is when incomings (rent) exceed outgoings (interest, rates, fees etc). Some people count interest only on how much they borrowed ie 80%.
I calculate on ALL costs. ie 100% + stamp duty costs, solicitor fees etc) because that money had to come from somewhere..
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