Much of the property investment undertaken in Australia by individuals takes advantage of negative gearing or tax leveraging.
In order to understand negative gearing it is valuable to understand how the taxation system works and affects you and your income.
We have a progressive tax system in Australia. What this essentially means is that the more income you earn the higher rate of tax you pay.
For the 2008 tax year, the taxation rates were as follows:
What the above table means is that, regardless of your income, the first $6,000 is tax free. The amount of your income between $6,001 and $25,000 is then taxed at 15% or 15 cents in the dollar. The amount between $25,001 and $75,000 or the next $50,000 is taxed at 30% and so on.
If your income is $50,000 then you only pay tax at 30 cents in the dollar on the amount greater than $25,000. The tax payable on $50,000 would be $10,350, calculated as follows:
It is important to understand how this relates to your personal tax and tax deductions.
When you claim a deduction for expenses, related to earning income, you are reducing your income by that amount. Your tax is then calculated on the remaining income.
A common mis-conception is that you get the entire amount of the deduction back in your tax return. This is not correct. For every deduction you have you save tax at the rate you would normally be paying it.
One of the things we do for our property investor clients is assess the taxation impact of their property investment. Understanding the taxation implications of property investing helps to assess the property investment itself and also assess future property investments and whether they are or may be viable.
If you are considering a property investment then we can help you determine the taxation impacts specific to your personal circumstances.
Find out more about negative gearing and how it affects you
Following is a real life example of one of our clients whom has had their property since July 2001.
The details of their property income and expenses, for 2007 tax year, were as follows:
The expenses have been broken into cash and non cash expenses. This will be relevant later. At this point in time the relevant aspect is the Taxable Income / (Loss) of ($10,870). This amount is the overall deduction that this person could claim as part of their tax.
This person’s employment income, group certificate, was $50,082. Tax payable on an income of $50,082 (for 2007 tax year) was $10,375.
The impact of the property investment is as follows:
The tax reduction associated with the property is $3,261
Cash-flow of Property Investment
An understanding of the cash-flow associated with the property investment assists in understanding and assessing the holding costs of the property – what does it actually cost?
The tax loss in the example is $10,870. This is not the cost of holding the property.
The tax reduction associated with the property was $3,261, this reduces the out of pocket cost.
In order to establish the actual, final, out of pocket cost the tax reduction ($3,261) is taken away from the tax loss ($10,870). In addition the aforementioned “Non-cash Expenses” also need to be taken into consideration.
The cash-flow of the property can be represented as follows:
The non-cash expenses largely consist of claims for depreciation. Depreciation claims are generally associated with newer property, though, you do not have to buy a property brand new to be eligible for such claims. The claims are generally higher with newer property.