Getting your head around investment property taxes can be a real headache, whether you’re a seasoned property investor or buying an investment property for the first time. But you can reap the financial benefits of investing in residential property if you know how to make the tax system work for you.
Investing in Australian property means you must pay rental income tax but you're also entitled to certain tax benefits. The more you know about the types of deductions you may be able to claim, the better prepared you'll be when tax time comes around.
This comprehensive guide will help you understand the tax implications of investing in residential property and the deductions that can be claimed to help you lower your holding costs.
Do you need to declare your investment property in your tax return?
If you earn money from renting out your property, then this needs to be declared as income when you lodge your tax return with the Australian Taxation Office (ATO). You’ll also need to pay tax on any rental income received.
You have to declare any rental income you receive in your tax return, even if:
- your rental property is overseas
- you live in part of the home
- you rent out the property to family or friends under market rates
What are the main types of property investment tax?
There are four types of taxes that property investors should know about.
Stamp duty
- This is charged when you buy a property, though concessions or exemptions may be available for those eligible.
- It’s a type of tax paid to the state or territory government when you buy real estate, specifically when there is a transfer of property.
- How much stamp duty will cost depends on:
- which state or territory the property is located in
- the value of the property
- whether you are eligible for a concession
Land tax
- This is charged on any land you own with a value exceeding the threshold.
- The threshold and the amount you pay differs by state or territory, land use and ownership type.
- The tax is levied by state and territory governments.
- Your principal place of residence (PPOR) is exempt from land tax.
Rental income tax
- You must pay this if you earn rental income.
- Your rental income forms part of your overall income, affecting your tax bill.
- How much rental income tax you need to pay depends on your tax bracket for the year.
Capital gains tax (CGT)
- This is a tax charged on the profit you make when selling your property, though concessions or exemptions may be available for those eligible.
- Often mistaken as a separate tax, CGT forms part of your income tax. Making a capital gain will add to the tax you need to pay for that year.
- Capital gains can be reduced by 50% if you are an Australian resident for tax purposes and if you have owned the property for 12 months or more.
- While you can’t offset a capital loss against your taxable income, you may be able to use it to reduce a capital gain in the same year or later years.
What are the types of tax breaks on investment properties?
One of the upsides of property investing is that it can come with tax breaks, but they come with different rules.
Generally, there are four main types of investment property tax deductions:
1. Claiming rental property expenses – The most commonly used investment property tax break is claiming deductions on rental property expenses. In other words, if you incur an allowable expense related to the lease, management or maintenance of your property, it’s likely to be tax deductible. By doing this, you can potentially offset your rental losses against your overall income. Generally, you can claim tax deductions in the financial year you incurred the allowable expense.
2. Negative gearing – If your property is negatively geared, you can reduce your taxable income by that loss. In simple terms, you may be able to pay less tax if you make a loss from your investment property. Let’s say you made $20,000 in annual rental income but also spent $30,000 on holding and maintenance costs in that year, then you would have a net loss of $10,000. If you earn an annual income of $70,000, your taxable income would be lowered to $60,000, reducing your rental income tax.
3. Depreciation – Depreciation is a tax break that is often overlooked or misunderstood by many property investors. If you own a residential rental property, you are entitled to claim the wear and tear of your property and its components as a tax deduction known as depreciation. To do this, you need a tax depreciation schedule prepared by a professional quantity surveyor. A depreciation schedule is a report that breaks down your investment property’s available year-on-year depreciation deductions. The good news is you only need to have it prepared once, rather than every year.
4. CGT discount - This tax break allows you to minimise the amount of CGT you pay when you sell your property, if you are eligible. Capital gains can be reduced by 50% if you are an Australian resident for tax purposes and if you’ve owned the property for 12 months or more.
How do you calculate rental income tax?
It's important for property owners to know how to calculate their tax obligations.
Rental income contributes to your overall taxable income. This means the tax on rent income is based on your marginal tax rate, or the highest rate of tax you pay on your income. Here’s a table showing tax rates for residents in 2021-22:
Source: Australian Taxation Office
Here’s a simple example:
- Let’s say you earn $75,000 from your day job before taxes and your investment property’s gross rent is $25,000 per year.
- Your taxable income would be a total of $100,000 (before deductions).
- If you have no other income, you’d fall into the $45,001 - $120,000 tax bracket.
- Your marginal tax rate would be 32.5%, which means your tax payable for that year would be $22,967.
What expenses can you claim to offset taxes on rental income?
You can offset various rental property expenses against your assessable income, depending on eligibility. Below are some common deductible expenses claimed by property investors at tax time:
- mortgage costs, including
- interest payments (excludes principal repayments)
- account fees and charges
- property management and leasing costs, including
- letting fee
- rental advertising fees
- ongoing property managements fees
- repairs and maintenance costs (excludes renovations and cosmetic improvements)
- strata levies/body corporate, council rates and utility bills
- landlord’s insurance premiums
- travel expenses associated with managing an investment property
- legal expenses related to owning an investment property
- cost of managing tax affairs, such as tax agent fees, and obtaining tax advice
How can you maximise the tax benefits of owning an investment property?
It's important that your rental property is run efficiently so that you can maximise the return on your investment and ensure that you don't miss out on any tax benefits you’re eligible for.
Here are some simple tax tips for property investors:
- Maintain a record of your rental income – Good record-keeping can make a big difference when tax time arrives. This could be in the form of a statement from your property manager, a rent book or bank statements showing the rental payments you receive.
- Keep track of your rental expenses – It’s good practice to log the expense type, amount paid and date. This includes bank statements showing the interest you pay on the mortgage for your investment property. Doing this will help you claim tax deductions for expenses incurred and negative gearing, so you don’t miss out on any tax benefits.
- Don’t throw away receipts – If you want to claim the tax benefits, you need to keep the receipts or invoices for your rental property expenses. You can’t claim the expense as a deduction if you don’t have evidence for your claim.
- Hold on to records for 5 years – You never know when the taxman will come knocking on your door. Records of income and expenses can be kept in physical or digital form. If you have multiple properties, your records for each should be kept separate.
- Consider hiring a tax professional – Managing the taxes on investment properties can be complex. Whether it’s lodging your income tax return or devising a long-term tax strategy, it could pay off to leave this to the experts.
Set up your investment property tax strategy
Having the right investment property tax strategy set up early doesn’t just help you save money. More importantly, it can help you avoid a lot of pain down the track.
Remember, there are different types of investment property tax benefits, so it’s essential to know how each works for your financial situation. It’s a good idea to seek professional advice from a tax accountant, depreciation specialist as well as your property manager.
Many people only think about their tax bills once a year. Being tax-smart means you should be reviewing your tax strategy continuously according to your goals and financial circumstances, just like your investment strategy.
