Tax return and understanding our tax is vital when we get into the property investing world. We want to make sure that we’re buying the right property, right location, right time. A part of that is structuring our finance and making sure the numbers add up and that links directly with maximising our tax return on that property to make sure the property is paying for itself. So how do we do that?
Okay, so we’ve got our investment property here worth Five hundred thousand, we’ve got Five hundred bucks a week rent which isn’t too bad, and which is Twenty-six thousand dollars per year. Okay, that’s all good. So how do we then work out what our tax return is? Our income for property is Twenty-six thousand a year. Let’s say we’ve got a salary on our job of a Hundred thousand a year, we then add the income from our investment property, Twenty-six thousand a year which means we have an annual income of 126K, salary plus rental income. Now we work out what the allowed deductions are. So we have our interest on our loan as our first reduction, we’ve got our council rates, rental management fees, insurances, we have strata management if we’re under a strata, any expenses attributed with the property are deductions and these are what we call ‘cash deductions’ because we pay those throughout the year, then we’ve got the kicker which is depreciation. Fifteen thousand dollars is the approximate depreciation on a property worth 500k, with a brand new property. So what that depreciation is, that’s the ATO saying the value of that property – the actual bricks, the carpet, the curtains, the electrical goods, the capital works of that building are actually depreciating in value every year. So that’s 15 grand in the first year alone and we can maximise that in the first five years. So your accountant will obviously help you with this and obviously you need a depreciation schedule to get this done. This is what we can help you with as well. So about 15k in depreciation, that’s free money, that’s a non-cash deduction. We don’t pay that throughout the year, that’s just what the ATO says you can claim against your property, which is huge. Okay so now we work out what our new taxable income is: Hundred twenty six thousand minus all our deductions gives us Eighty three thousand, that’s our new taxable income.
So the difference between that and the hundred thousand was 16,450 that we paid tax on, therefore if we are working off a thirty seven percent tax bracket, our refund will be approximately 6,260 or just over 6,000 dollars. Not too bad for one property, so if we have three, four, five properties in our portfolio and we’re paying thirty/forty thousand dollars in tax a year, we’re getting majority of our tax back. Now yet we are paying money throughout the year in order to get that tax back but what that tax is doing it’s allowing that property to be positively cash flowed, negatively geared positively cash flowed which more importantly is allowing us to hold an asset with half a million bucks in the market that market moves ten percent you make 50k in that year.
So negative gearing and positive cash flow – how does it work? Okay so we have value of our property or the value on the left hand side and time down the bottom. The cost to hold that property increase over time usually at the rate of inflation about two percent, the income from the property increases over time at the rate of the value of the market that we’re in, so hopefully we’re in a market that’s growing between six and ten percent per year if we’re buying the right properties so that the income, rent and tax increases at a higher rate than the cost. So if our costs are higher than income that’s negatively geared, once the income is greater than our costs that’s positive cash flow and obviously the neutral point of break-even point is right there so when we first buy our property we might be in this space here, we might be slightly negatively geared then we add our tax return to our rent and that pushes us into the positive. The longer we’re in the positive the better it gets. Therefore holding your asset for as long as you can, time in the market is vital.
So here we go. At a minimum, we want it to be negatively geared but positive cash flow. Gearing is before tax, so that’s the negative space and then cash flow is after tax. So once we have our tax return, we add that to the rent and then we should be in that positive space. If we’re not, we’re buying the wrong properties in the wrong market at the wrong time and we’re stuck in this space here where 90% of investors find themselves and can’t get out. So therefore it is possible for property to be negatively geared but positive cash flow, that’s key.
So if you have any other questions or need any more tips or help on how to structure your properties to ensure you’ve got the right cash flow feel free to drop me a line on firstname.lastname@example.org and myself or one of my team will get back to you ASAP. Look forward to hearing from you. Cheers, Nic.