You’ve probably heard it from time to time that you can get a tax refund from an investment property. But what does this really mean?
Generally speaking, the Australian Taxation Office (ATO) allows you to offset rental losses against other income (eg. employment income), thereby reducing your taxable income. As you would have already paid taxes on your employment income via Pay-As-You-Go (PAYG) withholding taxes through your employer, this means that you have overpaid taxes and are entitled to a refund of overpaid taxes.
[Note: Unlike Singapore where you pay your tax instalments in advance directly to IRAS via GIRO, here in Australia, this is all handled by your employer through their payroll system.]
What do you mean by rental losses?
Aha! Again this is pretty much an Australian concept. Unlike the Singapore rental market where tenants are mainly foreigners/expatriates on high income who prefer fully furnished properties, resulting in decent rental yields on investment properties and rental profits for landlords, the reverse holds true in Australia.
The tenant base in Australia consists mainly of young singles starting out after moving out of their family home, families who prefer to rent bigger homes or homes in better locations than they can afford on a mortgage or even long-term tenants who simply cannot afford to save up a deposit for a house.
There are also the free-spirited ones who prefer to rent throughout their lives so that they are not tied down to one property or location and are free to uproot anytime, even moving interstate without much hassle.
Australian tenants usually prefer unfurnished properties as they will move their own furniture and appliances into the property. This is another reason for lower rental yields compared to fully furnished properties.
It is also the landlord’s responsibility to pay for council rates, park charges via the water rates bills and general repairs and maintenance of the property for appliances like dishwashers, ovens, rangehoods, hot water service, heating/cooling system, smoke detectors, etc.
What this has resulted in is that it is generally cheaper to pay rent than to buy and service mortgage instalments in Australia. This means that landlords tend to be out of pocket despite collecting rent. Most landlords willingly make this loss in the hope of capital appreciation on their properties and for tax refunds.
Before you rush out to purchase an investment property in order to receive tax refunds, be aware that you have to lose $1 to get back anything between $0.19 to $0.47 per dollar, depending on your marginal tax rate. This tax refund is NOT free money.
Depreciation & Paper Lossses on Rental Property
Despite being in a negative cashflow situation, landlords do have a trump card up their sleeve. That’s depreciation.
The ATO allows landlords to claim deductions for Division 40 depreciation on various items in the property (eg. blinds, carpets, dishwashers, light fittings, stoves, rangehood, etc.) and Division 43 depreciation on the building over a period of 40 years.
These deductions either reduce any rental profits or increase rental losses without impacting on the landlord’s cashflow. The landlord is not out of pocket for these deductions, so in reality, these are losses on paper.
There is a sting when you sell the rental property though – part of the depreciation (Division 43) actually reduces the cost base of your property, resulting in a higher capital gains. But we’ll leave this for another time, another day.
Before you get too excited about calculating depreciation, be aware that there are specialists (quantity surveyors) that are licensed to prepare such detailed reports which list every single possible depreciable asset.
It is also worthwhile noting that depreciation is higher on newly constructed houses compared to older houses. There was also a change in laws a few years ago where an investor who acquires a residential rental property after 7.30pm AEST on 9 May 2017 from a previous owner (‘second-hand property’) will not be entitled to claim Division 40 depreciation from 1 July 2017 for existing depreciable assets in that property.
Disclaimer: This basic article on taxes was written by ‘Life in Melbourne’ in consultation with a registered tax agent. We suggest that you seek the advice & services of a tax agent instead of relying solely on any material you may find online, including this article.