In this third article in our series on the tax issues involved in property investment we look at Goods and Services Tax (GST), Income Tax Withholding Variation (ITWV) and other tax types not covered so far. In part one we covered how to best structure your investment property ownership for maximum tax benefits, as well as the deductions you may be able to claim. In part two we explained depreciation and Capital Gains.
Goods and Services Tax
If you’re buying and selling rental properties in a business and you are registered for GST you may be able to claim certain GST liabilities associated with buying property.
If you’re registered for GST and it was payable or charged in relation to your rental income and property management do not show it as part of your income or input tax credits on your tax return.
Typically you’ll purchase a rental property as an individual (not through a business) for the purpose of tax effectiveness or negative gearing where the greater marginal tax rates provide increased tax benefits (see part one of this series)
In this case you may be able to use the margin scheme when acquiring land or property where the GST may apply.
The margin scheme may be used for all types of property including residential, commercial or retail and is relevant where the purchaser is not entitled to an input tax credit on GST paid in an acquisition.
Typically you would pay the amount of GST being 1/11th of the purchase price. Under the margin scheme you pay the revised GST amount of 1/11th of the margin for the supply. In this case the amount is calculated only on the difference between the final purchase price and the value of the property as at 30 June 2000 (or, if purchased by the vendor after that date, the vendor’s original purchase price, 1/11th of the margin).
A rental property is negatively geared if its bought using a debt or finance facility and its net rental income, after deductions, is less than the interest cost of finance.
The overall taxation result of a negatively geared property is a net rental loss. If this is the case, you may be able to claim a deduction for the rental expenses against your overall incomes – rental income, wages, salaries and other income – when you make your tax return.
Negatively gearing allows investors to purchase a brand new rental property and combine the rental income with the overall tax benefits (increased net income) to help fund the cost of maintaining the property.
By researching and choosing a rental property with the optimum balance of yield (rental income) and factors contributing to tax effectiveness (size for depreciation, deductible expenses including finance and other servicing costs) an investor can control their out of pocket expense (personal injection) required to fund the investment, thereby maintaining their current or desired standard of living.
In many cases negative gearing will produce a significant tax refund on your tax return. If this is the case you may reduce your rate of withholding by your employer to better match your end of year tax liability.
You can do this by applying to the Tax Office for a withholding variation using the PAYG income tax withholding variation (ITWV) application.
Income Tax Withholding Variation
You can reduce the burden of funding your rental property investment during the year by applying for a withholding variation using an ITWV application. This process allows you to reduce your PAYG withholding rate and receive your tax benefits in your net pay each period throughout the year rather than receiving a lump sum in your tax return at the end of the financial year.
This is a good tool for those who have difficulties managing cash flows and tend to spend the lump sum on other costs or items (plasma TV, jet ski or bits and pieces) rather than using the tax benefits for funding the investment property.
For example if a rental property owner typically received an end of year tax refund of $11,500 because of the deductions produced from their rental property against their overall assessable income, they would receive approximately $221 per week ($11,500 / 52 weeks) increased net pay after lodging an ITWV.
The increased net income plus the rent will assist in funding the investment throughout the year.
Remember, an ITWV means the tax office is not giving you an extra $221 each week. It means the tax office is taking $221 less each week because of your deductions and withholding rate change. Therefore, you are not taxed on this money.
The ITWV allows you to forecast your deductions for the upcoming financial year and the tax office can adjust your withholding rate accordingly. After lodgement, the tax office will send a letter to your payroll office advising your employer to tax you at the new rate.
Pay As You Go instalments
If you’ve invested in cash flow positive properties (you make a profit from renting your property) you may have to make PAYG instalments to the tax office each quarter throughout the year.
While cash flow positive properties make funding the rental property easier for the investor, their higher yield usually comes at the cost of increased maintenance (typically older properties) and forgoing significant tax benefits and capital gain for portfolio growth.