posted in: Investment Advice
New tax changes to investment properties – what does this mean for the average investor?
Unless you’ve been hiding under a rock, you would have heard the countless chatter around negative gearing and the political power play that took place between our major political parties prior to the last Federal election. Although it was Labour that proposed to limit negative gearing to new properties, it was the Liberal party who took government and they’ve since implemented their own changes to the deductibility of property as an investment in the recent budget.
So, what are the recent changes and what do they actually mean for the average investor? Let’s start with the technical first:
- From 1 July 2017, investors are no longer able to claim tax deductions for travel expenses related to inspecting, maintaining or collecting rent for a residential rental property. These travel-related deductions were often described as a holiday and were an obvious target for the ATO
- Negative gearing will remain in place for both new and existing properties. This means that an investor can claim a tax deduction against their annual income if the costs of running their investment exceed the income received. Under Labour’s proposal, this would have been limited to new properties
- Depreciation is also classified as a tax deduction. There are two types of depreciation: ‘Building Allowance’ and ‘Plant & Equipment’. ‘Building Allowance’ relates to the cost of constructing the building. Under the new changes, this type of tax deduction will remain in place for new and established properties
- Depreciation on ‘Plant and Equipment’ relates to the ability to write off the cost of fixtures and fittings such as carpets, dishwashers, ovens, blinds, etc. Under the new changes this type of tax deduction will only remain for the original owner of brand new properties or in instances where the items were personally purchased by the investor themselves. Established items in established properties will no longer be depreciable under the new changes.
Ok, so what is depreciation?
Well, to help you understand the first question, think about what happens to most brand new cars. The minute they leave the showroom their value falls and tends to keep on falling until they turn up as scrap metal (a few classic models excluded). This loss in value over time can potentially be offset against an individual’s or business’s taxable income, even if they still own and drive the car.
Property is no different. The Australian Taxation Office (ATO) recognise that the actual value of the physical property and its items are actually reducing in value over time, hence they will allow an owner to offset this perceived loss of value as a tax deduction. This is different to the land component, which is typically assumed to increase over time.
So what does the changes to depreciation for ‘Plant and Equipment’ actually mean to individual investors?
Well, let’s assume an investor on an average income of $80,000 p.a. decides to purchase a new property valued at $600,000. If we assume a year 1 depreciation figure for ‘Plant and Equipment’ of $9,000, then based on the purchaser’s marginal tax and Medicare rates (32.5% + 2%), the purchaser will receive back an extra $3,150 in their annual tax return – or $59 per week. If the purchaser happened to be a higher rate taxpayer (45% + 2%), then based on the same scenario they would receive an extra $4,230 or $81 per week back in their tax return.
Unlike deductions for ‘Building Allowance’ which remain constant for 40 years, depreciation on ‘Plant and Equipment’ reduce gradually over time. However, for many investors, it’s often in the early years of the investment when those extra few thousand dollars provide the greatest assistance, particularly as rents tend to rise over time negating the need and benefit of ongoing tax deductions.
So when are the depreciation changes actually taking place?
In the most recent budget the Liberal government drew a line in the sand stating 9 May 2017 was to be the date of the change. These changes are still to be signed off as legislation, but the legislation is in the Senate and according to those in the know it’s just matter of when, not if, the changes will be enforced.
Purchasing a significant investment for tax reasons alone has never been a sound investment strategy, however, the changes to depreciation do stoke the debate of the benefits for established versus new property when it comes to property investing.
There are many other fundamentals that go into selecting the right investment property and investors should seek professional advice if they want to invest with confidence. This information is general in nature and not designed to constitute financial or tax advice. The team at Binnari recommend that investors seek advice from a qualified financial planner or accountant when it comes to understanding the tax implications of any potential investment property.