Well, the tell-tale signs that we are near the end of the financial year are upon us! Advertisements for EOFY sales are everywhere we look, search parties for those mislaid receipts, and the usual tax time property jargon such as “depreciation” and “negative gearing” being bandied around the water cooler.
Real estate at tax time has its own language and terminology which can be very confusing, particularly if you’re new to the investment process. Here’s a guide to the key phrases used at this time of year when we are thinking about your property investments, and what that means for your tax!
Capital Gains Tax (CGT)
A capital gain, or capital loss, is the difference between what it cost you to acquire an asset and what you received when you disposed of it. Selling assets such as real estate is the most common way you make a capital gain or capital loss. In other words, you make a capital gain when you sell a house for more than you paid for it.
You pay tax on your capital gains. So, when you make money from the sale of a property, it forms part of your income tax and is not considered a separate tax.
Most real estate is subject to CGT. This includes vacant land, business premises, rental properties, holiday houses and hobby farms. Your ‘main residence’ (family home) is generally exempt from CGT unless you rented it out for a time or it’s on more than two hectares of land.
If you are a property owner, capital gains tax may become an issue when you make a profit from selling your property. But there are a couple of standard exemptions which could assist. For more information, we can help you with a referral to an accountant, or visit the Australian Tax Office website.
The term ‘negatively geared’ sometimes causes confusion, especially among people new to the intricacies of property investing. Negative gearing occurs when the costs of owning a property – interest on the loan, bank charges, maintenance, repairs and capital depreciation – exceed the income it produces. Simply, at the end of the day, the investment property in question will run at a loss and you need to make up that shortfall from your own pocket.
Negative gearing can be used as an investment strategy in order to reduce your taxable income, maximising available tax benefits. If the property becomes cash flow positive (see below), this profit is added to your taxable income and you may have to pay more tax depending on the structure of your investments.
Like the name suggests, depreciation is the decrease in value of an item over time. An example of a depreciating asset is your car, which is said to reduce in value a great deal from the time you drive it out of the dealership.
When it comes to investment properties, depreciation can certainly work in your favour. If your investment property depreciates, you can claim against the decreased value of your investment. Negative gearing and depreciation allowances are popular ways to reduce your tax liability. There are various rules around this in all States, so please speak to a professional, or we can get you in touch with the experts!
Cash flow positive
The reverse of negative gearing, your investment property is considered to be cashflow positive if your income generated from the property is greater than your outgoings – after you’ve taken into account tax deductions. Tax deductions include things like interest paid on your loan, depreciation, maintenance and service costs.
Equity is the difference between what your residence or investment property is worth and how much you owe on it.
Put simply, if your property is worth $300,000 and you still owe $100,000, you have $200,000 in equity. Over time, as you reduce the amount you owe on your home or the value of your home grows, your equity increases. Equity is a very good thing to have as it can be used to leverage further property purchases without your having to save a new deposit.
Of course there are lots more real estate and legal terms you will come across at tax time and when investing in property. We recommend you seek professional advice. Contact us to learn more.
(POST REPRODUCED WITH PERMISSION FROM CONNECTIVE AGGREGATION)