Browse Forums Home Finance 1 Feb 21, 2011 8:18 pm Hi guys, I have a somewhat hypothetical scenario for an investment property below. I am trying to learn how an investment property works. It's quite long but this might also be educational for others. Please bear in mind I am not an expert so don't treat this as advice. I want some input as to whether my understanding of the following is correct. Initially I want to construct a new home on a block of land in Victoria. Land price = $150,000 Construction price = $250,000 TOTAL price = $400,000 I will be treating this as my residence for the first 6 months, which entitles me to the FHOG (which is $20k for a new home). Rental After 6 months I want to convert it into a rental. This is perfectly legal as far as I'm aware. Once I start renting it out, I have to declare my rental income, but can deduct interest and other expenses (insurance, rates) and depreciation. E.g. Rental income = $20,000 pa Interest expense = $24,000 pa ($400,000 * 80% borrowed * 7.5%) Insurance/Rates = $2,000 Depreciation = $6,250 (construction price divided by 40 years) So my "Negative Gearing" loss would be $12,250, and assuming I was taxed at 40% would give me a tax refund of $4,900. Bear in mind that my taxable loss was $12,250 but the depreciation part is not "realised", meaning it does not actually come out of my pocked, but is a theoretical depreciation on the value of the building. So the actual loss out of my pocket would be $1,100 ($20,000 - $24,000 - $2,000 + $4,900). Capital gains After renting it out, I am no longer exempt from paying capital gains tax when I sell the house. Because I am also depreciating the house each year, this lowers my Cost Base which means I need to pay more tax when I eventually sell the house. So assume after 1 year that I sold the house (original price = $400,000), for a new price of $412,000 (a modest 3% rise). Sale price = $412,000 Cost base = $400,000 - $6,250 = $393,750 Capital Gains = $18,250 (Sale price - Cost Base) Because I held the house for 1 year, I'm entitled to 50% reduction in capital gains tax. Tax on Capitals Gains = $18,250 * 50% * 40% (tax rate) = $3,650. So the net capital profit in my pocket after selling the house is $12,000 (actual profit on house) - $3,650 (capital gains tax paid) = $8,350. (In reality one would pay agents fees, etc when selling so pretend that we actually kept the house for several more years so we could lessen the effect of the fees). That means after year 1 our position is Net rental loss of $1,100 Net capital gain of $8,350. (In the example above I put in a 20% = $100,000 deposit so I should really deduct the lost interest from that also, which is roughly $6,500 (gross at 6.5%) or $3,900 once tax is taken out.) Does that make sense? Have I missed anything? Murphy11 Re: Tax on an investment property 2Feb 21, 2011 8:39 pm It is a very complicated business. Depreciation can be calculated over 40 years as a flat rate as you have done or on a diminishing scale (i.e $15,000 in year one, then $13,500 in year 2, $12,400 in year 3, and so on until you claim the final amount in year 40 of about $200 - just ball park figures but gives you the idea). This allows you to maximise your claims in the first few years, after that hopefully rents will rise to offset your diminishing appreciation. Also if you live in the house during a period of good capital gains you can get a valuer to revalue your property just prior to it be a rental and then you are only liable for CGT on the Capital gains since the place became a rental. Otherwise your figures/understanding is good. There are so many regulations and different ways to do it - best to get some advice from a good accountant. Building an Eden Brae Saville 27 http://karry327.blogspot.com/ Building thread https://forum.homeone.com.au/viewtopic.php?f=31&t=44247 Re: Tax on an investment property 3Feb 23, 2011 7:28 pm I've seen how the diminishing value method works, and agree that would be better for an investment property, especially in the first ~10 or so years. For simplicity, I left it out of my example. I didn't know you get a revaluation before you start renting it out - thanks for the tip. Not sure if anyone else has anything else worth mentioning here. Hopefully I've covered all the basics. Murphy11 Re: Tax on an investment property 4Feb 23, 2011 8:08 pm The only thing I find worth mentioning is Thanks guys! Where you are coming from is where you are going to... Re: Tax on an investment property 5Feb 28, 2011 6:11 am This is a great illustration and the revaluation tip is amazing. I have some only minor things to add: 1. You might also calculate the incremental interest lost from the Rental loss that you need to cover as you would ordinarily put that money in the bank. 2. You might have some agent fees when renting. Love your work Re: Tax on an investment property 6Feb 28, 2011 8:03 am Hi Murphy11, Also with regards to the Depreciation, you don't just depreciate the building. Get a real Quantity Surveyor in there to do a "depreciation schedule". They will also depreciate all of the internal fixtures and fittings. They depreciate at a faster rate depending on what they are. Carpets, for example, fully depreciate over 5 years and other things depreciate over 7 years (timber floors, any window dressings) or 10 years (hot water services) in full. That means that the cost base at sale time will be lower again before they apply the capital gains tax. SK Build thread: viewtopic.php?f=31&t=34120 Handover 23 Dec 11 Squatting 21 Dec 11 Fixed 12 Oct 11 Plastered 31 Aug 2011 Framed 7 June 2011 Site Start 7 Feb 2011 Land Titled 18 Jan 2010 Land Deposit 25 Jun 2009 the exemption applies only to your principal place of residence - so you must live in it. The 200 days is continuous. You also have to apply for the exemption. 2 13318 If it's your primary residence then there is no tax deductions to be made. 4 125307 You might be able to apply to divert the sewer at your expense. In NSW you would contact a Water services co-ordinator and they would give you advice as to whether or not… 1 16147 |