Tax | negative gearing deductions any expenses incurred on an asset not producing income. How does it work? In addition to the tax breaks, the investment continues to make capital Using an investment property as an example, a simple application gains during this time. of negative gearing can be demonstrated as follows: How to Sarah purchases a house as an investment for $400,000. She has What expenses can you claim? borrowed the entire amount at 10% pa interest, making the annual In order to maximise your total tax- interest repayments a total of $40,000. deductible amount at the end of the If the house is rented out for $400 a week, this gives Sarah an annual financial year for a property that’s max out your negatively geared, there’s a range of rental income of $20,800. The cost of the rates, home maintenance, expenses that can be included in the insurance, agent’s fees and so on total $5,000 a year. She can also total annual cost of the property for depreciate the property at a rate of $5,000 per year. deduction purposes. Mortgage interest .................................................................. $40,000 Prepaid expenses Rates, maintenance, etc ...........................................................$5,000 tax benefits through Depreciation ...............................................................................$5,000 1 It’s possible to claim any prepaid expenses that are related to your Total expenses ................................................................. $50,000 income-producing asset. Rental income ................................................................. $20,800 If the payment covers a period of 12 negative gearing months or less and the period ends on Total loss ......................................................................................$29,200 or before 30 June, the expense can be Negative gearing has long been used by spruikers to lure There are two important things deducted immediately for that income The shortfall of $29,200 ($50,000 minus $20,800) is tax deductible from unsuspecting investors wanting to make a quick buck in to note when considering whether year. But, if the repayment is for more Sarah’s gross income at the end of the financial year when assessing her negative gearing is appropriate for than a 12-month period and more than taxable income. This results in a considerable tax saving for Sarah while she property. But while the strategy can offer substantial tax your situation. $1,000, it may need to be spread over holds the investment. relief, it can also result in massive losses. Michael Quinn, First, you must have other forms two years or more. of assessable income in order for this Examples of expenses that can Sarah’s tax refund lawyer, accountant and director of The Quinn Group, to work. Otherwise, you simply incur be prepaid include costs associated 30c tax threshold – $8,760; 40c tax threshold – $11,680; shows how to make it work for you a loss as there is no income to offset with preparation of leases, payment 45c tax threshold – $13,140 it against. of interest, insurance, rates and body And secondly, the investment is corporate fees. If you repay the loan early, and Legal expenses hile negative gearing is most purchased with one of two possible in less than five years, you can claim 4 There are a number of legal commonly associated with outcomes in mind. Borrowing expenses a deduction for the balance of the expenses which are deductible under W property investment, it can Either there is the expectation that 2 These are expenses directly borrowing expenses, in the year of various sections of the Income Tax also apply to the investment of other current losses are going to turn into incurred in taking out a loan for final repayment. Assessment Act. assets such as shares or bonds. profit over time, or it is sold for a your property. They can include If you obtained the loan The most important of these are The term ‘geared’ refers to any capital gain which is big enough in establishment fees, valuation fees, part-way through the income associated with the preparation of investment that is purchased with the total to cover all past losses incurred. title search fees, costs of preparing year, the deduction for the first leases, the registration of patents, assistance of borrowed funds. Thus a A good investment is, above all, designs and copyrights, and debt ‘negatively geared’ investment is one designed to create a profit. collection fees. This can also include that is purchased with the assistance of While negative gearing initially The fact that, historically, property prices the costs involved in evicting a non- borrowed funds and, after deducting provides tax breaks, both the ongoing paying tenant. other expenses, the net rental income profit and capital gains options continue to rise over time is equally Most legal expenses are of a is less than the interest paid on the eventually have to generate a profit capital nature and are, therefore, borrowings in any income year. and – as a result – a taxable income beneficial to the investor, as it’s likely that not deductible. These include costs At first glance, it is understandable amount, to be effective. of processes such as purchasing or that you might think to yourself: “Why So, you need to be confident that the investment will generate a capital gain selling your property, resisting land would anyone buy an investment that one of these two options is likely, resumption and defending your title to is losing money?” based on your investment choice. and filing mortgage documents, stamp year is apportioned according to the the property. But the benefit of this situation If, upon assessment, these outcomes duty charged on registration of the number of days in the year you had For capital gains tax purposes, is that, where negative gearing is are unlikely, negative gearing is mortgage and mortgage insurance the loan. however, non-deductible legal concerned, the entire shortfall amount probably not a wise option and you (where applicable). Interest costs do expenses may form part of the can be deducted against the investor’s would need to assess whether the not qualify as borrowing expenses. Mortgage discharge expenses cost base or reduced cost base of other assessable income. The fact that, investment itself is, in fact, a good one. If the total cost of these items is 3 Provided that the mortgage was your property. historically, property prices continue It’s also not possible to negatively over $100, the deduction is spread used as security for the repayment of to rise over time is equally beneficial to gear an investment that does not over five years or the term of the loan, money borrowed to produce assessable Deduction for decline in value the investor as, in the long term, it is produce an income. whichever is the lesser. If the total cost income, the costs of discharging the 5 of depreciating assets likely that the investment will generate Under sec 51 of the Income Tax is $100 or less, it is fully deductible in mortgage are deductible in the year From 1 July 2001, the uniform capital a capital gain. Assessment Act 1936, you cannot claim as the first year. they are incurred. allowance system (UCA) applies to 86 www.yipmag.com.au www.yipmag.com.au 87 Tax | negative gearing for expenses such as clearing land prior to the construction, landscaping or the cost of the land that the rental property is built on, as the value of the land is not depreciated over time. Yes! Negatively gearing your home is possible This is done by establishing a discretionary family trust with a shelf company to act as trustee. You and your family then rent the house at a proper market rental on a long-term lease. Be aware, however, that if the home is owned by a trust, any capital gains exemptions may be lost and you also may be liable to pay land tax. But your lease on the house will Assets claimable as depreciable include be valued for capital gains tax and, meanwhile, you can claim any interest airconditioning units, electronic security payable, insurance, rates, repairs and depreciation as tax deductions. systems, rainwater tanks, TVs, antennas, Once you have established negative gearing on the property you can, if roller-door motors and washing machines you wish, provide your employer with a PAYG Variation Certificate. This most depreciating assets, including using a diminishing value rate of allows your employer to give you those acquired before that date. 37.5%. Low-cost assets that are added reduced PAYG deductions, providing The UCA consolidates a range of to the pool are depreciated at half the for the losses that are being incurred former capital allowance provisions, rate – 18.75% – for the year in which on your property. including those relating to plant and they enter the pool. equipment by providing a set of general Seek advice rules that applies across a variety of Capital works deduction Negative gearing can be a beneficial depreciating assets and certain other 7 You may be eligible to claim investment tool for the right person if capital expenditure. a deduction for the construction it is applied correctly, and the necessary You can calculate deductions for expenditure related to these expenses. research and projections are carried your depreciating assets’ decline in Known as capital works deductions, out prior to execution. Without sound value using these new rules, and these are usually spread over a period professional advice there are many then deduct an amount equal to the of either 25 or 40 years. hidden traps that could see a potential decline in value for an income year of a It’s necessary to point out that total money-making venture turn into a depreciating asset that you held at any capital works deductions must not be financial-loss nightmare.