The Australian Tax Office
assists the investor
When a property is negatively geared, and tax rebates calculated, the investor has the option to either collect the credits progressively over the year or to wait until the end of the financial year and receive the refund then.
Which option you choose will depend on your circumstances, cash flow, fiscal discipline and preferences.
The Australian Tax Office provides online access to submit a variation, though relying on professional assistance is recommended.
If cash flow is not an issue, perhaps for a first or second property purchase, the investor can elect to hold off and wait until the end of the financial year to receive their entitlements.
In the case below, the investor decides to carry all the costs of ownership and wait until the end of the financial year to collect their rebates, in a lump sum or offset against other tax outstanding.
In this case, what would be due from the ATO is foregone and carried by the owner until the EOFY. The out of pocket or holding costs, therefore, are more substantial pay by pay.
This constitutes forced saving. Remember the opportunity cost! Covering the expenses along the way will prohibit some discretionary spending, but that may be a beneficial strategy for those who struggle with delaying gratification!
You are effectively giving the tax office an interest-free loan of your money!
The alternative is to collect the tax rebate entitlements each week (may also be fortnightly or quarterly depending on the investor’s pay period).
The pay office takes less tax out of each pay in line with an Income Tax Withholding Variation form submitted to the ATO.
As an example, if your accountant calculates that you will be entitled to a $7215 rebate at the EOFY, you can elect to have $138.75 ($7215/52 = $138.75) less in tax withheld. Your pay office adds that to your pay instead of remitting it to the ATO as they usually would.
Effectively you end up with more in your pay packet, but the ‘extra’ $138.75 must be directed into the account from which your property investment expenses are paid.
Your accountant is best equipped to submit an Income Tax Withholding Variation. The ATO imposes strict tolerances around how far out you can be when estimating what you are entitled to collect. Their limit of a discrepancy is usually no more than 10%, so it’s best to have a professionally prepared estimate lodged on your behalf; otherwise, penalties may apply.
Collecting your rebates pay by pay assists with cash flow and may become more important as your portfolio expands or perhaps as your life circumstances change, for example, an addition to the family.
The example below illustrates the situation where rebates are collected pay by pay and the investor’s contribution is subsidised week by week so that they now only have to find an extra $25pw to hold the property.
Gearing is borrowing
to buy an asset
with a small personal contribution and
borrowing the rest from others
Property investors aim to earn income from the property in the form of rent in the short term and a capital gain, long term.
Property investment is negatively geared when the rental income doesn’t cover all the costs associated with owning the property.
The Australian Tax Office allows property investors to reduce their taxable income by the amount of the shortfall.
It is also important to note that property can be positively geared, where the income received exceeds the holding costs. Neutrally geared property exists where after all income and expenses are calculated, the property ‘breaks even’, that is the rent covers the expenses but no more.
Any property can be positively or neutrally geared depending on the LVR and the size of the investor’s contribution.
Typically though the idea of a positively geared property relates to the concept of the rent exceeding the holding costs with only a minimum deposit, this is more likely in rural areas where prices are low and rents typically much higher relative to the purchase price. The trade-off may be lower capital growth long term.
Why negative gearing is here to stay
= “Why negative gearing is here to stay…”] Once again the idea of changing the tax benefits afforded to investors via negative gearing has been floated in the context of broader tax reform.
Australia is a market economy and, in a perfect world, freely operating markets are efficient and deliver maximum satisfaction for all. But it isn’t an ideal world. Sometimes market solutions are inadequate, inequitable and lacking in social responsibility- you only have to look at the causes of the GFC to see a classic example!!
There is a role for government to redistribute income and resources in ways that enhance market solutions and compensate for market failure.
Tax benefits for negatively geared investment property are a perfect example of government policy designed to achieve a desirable market outcome. The government provides tax incentives for individuals to invest in property, especially new property, thereby increasing the stock of available housing and delivering significant employment opportunities as a byproduct. The stimulus to private sector property investment through tax concessions helps to redress the housing imbalance and reduces pressure in the rental market.
It also importantly promotes entrepreneurial spirit, the building block of the market system, and is an incentive for individuals to create wealth for their retirements, thereby reducing the burden on future generations. Shifting the goalposts to be eligible for the age pension to 67 after 2023 is in direct response to the looming crisis in the economy’s ability to support an aging population that no longer contributes to the public purse.
We all need to become proactive now so that we don’t end up reliant on the overstretched welfare system in the future. It is also essential to understand why tax benefits are maximized on a new property through depreciation.
Depreciation means that you are allowed to claim a proportion of your property’s value, the building and its fixtures and fittings, for wear and tear over time as another cost of ownership. This claim is most substantial in the early years of a property’s life and so building a new property is the best way to take advantage of the ATO’s concessions.
A healthy building industry is vital for economic growth and employment. The multiplier effect of construction means not only work for tradespeople and suppliers, but it has a ripple effect on the retail industry for white goods, carpets, blinds, turf, fencers, landscapers, moving companies, and the list goes on! No wonder the government considers ‘housing starts’ a leading economic indicator.
Policy changes involve trade-offs and disincentive effects, both intended and unintended. Removing tax advantages for property investment would reduce the supply of housing and put the onus back on the public sector to provide more public housing.