Less for More: Lower Taxes Through House and Land Investment
There are many ways to legally reduce the amount you pay in annual income tax.
In Australia, one of the most popular ways is through house and land investment. In fact, 83% of all land investment in Australia is from small-scale investors. This refers to people who have already purchased their own home, and they are now investing in other properties.
Investing in land and property as a means of reducing your taxable income is achieved through what is called “negative gearing”. Keep reading to find out what this is.
How Does it Work?
First of all, let’s answer the question – what is “negative gearing”?
“Negative gearing” is simply purchasing land with the use of debt in the form of loans.
After taking out the loan to purchase a property, investors then rent out the property.
However, the interest charges on the loan are more than the income earned through renting the property. This means that you incur a financial loss annually.
That loss is subsequently taken off your annual income. This reduces the amount of overall income tax you are subject to pay.
You may be asking yourself at this stage – “wouldn’t I be losing money?”
Well, yes you would be losing money at first. But, if your investment gains capital growth over the next few years, you will be making money.
This is because, by reducing your overall income, you can save a huge amount in income tax – and this could be greater than the money lost.
But that’s not all. You have to be patient and look at the bigger picture.
Real estate values in Australia rise at a greater rate than inflation. For example, in Sydney, property prices have risen over 20% over a twelve month period between 2016 and 2017. That is an incredible increase.
This means that through land investment you can do more than reduce how much you pay in income tax. At a later stage, you could also make more money by selling your property at a higher price than you originally purchased it for.
Imagine if you took out a loan to make an investment for $500,000. On that loan you have to pay interest payments to the sum of $30,000 annually.
However, you are also renting out the property to a tenant. The tenant pays you $20,000 per year. Therefore, you incur an annual loss of $10,000.
As a result, $10,000 is deducted from your annual income, so your taxable income is less. After a while, you could sell the property that cost you $500,000 for $600,000. That is a profit of $100,000.
While that is recognised as taxable income, it will be taxed at the marginal tax rate.
However, in Australia the tax system encourages this kind of investment. This means that investors can get a 50% deduction on their capital gains tax. In other words, if you own the property for over a year, only 50% of the $100,000 financial gain would be subject to tax.
So, when you do your tax return at the end of the financial year, you should get quite a hefty tax return, due to all of the expenses you have paid for your investment property. This is when you can get your accountant to fill in a ITWV. Most people have not heard of this!
Then the ATO will do an assessment of your application and your latest tax return, then send a letter to your employer asking them to reduce how much tax you should pay. So you will end up getting paid more cash, which means you can easily pay for your holding costs on your investment properties.
So, as an example, last year I paid $12,000 in tax. Due to all of my costs for my investment properties that year, I was able to claim back $11,000. The ATO recognises that I do not need to pay full tax for the next year because I will claim it back any way.
After receiving a letter from the ATO, I am now paying around $57 in tax per fortnight, WOW. This is great news – I can now afford to think about buying another house. I am literally using tax dollars to buy investment property.
Now that you understand how land investment could save you money in the long run, you may be wondering where to invest. It is important to consider the question carefully.
Although this is always a personal decision of the investor, there are some suggestions for what you may want to consider.
It is advised to invest in familiar markets – that means properties in areas that you know about. This saves time on research because you have a general idea of property prices and the right neighbourhoods.
Another good tip is to identify emerging areas with growth potential. This refers to areas with great potential to make financial gains, in which you are likely to see a return on your investment.
Good areas for investment include those that have greater rental yield and low vacancy rates. This means that you should look out for areas where the average rent is higher in comparison to the property prices, while vacancy rates are low.
Another indicator of the value of an investment is if there are planned developments. This can have a negative impact (e.g. airport) or a positive impact (e.g. green spaces) on your investment.
One of the best options is to seek professional advice about buying properties in high growth areas. They do all the research into town/city planning and they often have insight into aspects that may be beyond your own understanding. ClickHere to find out more.
Other Financial Considerations
It is important not to overlook the other financial considerations involved in land investment. For example, your investment could include additional costs of stamp duty, LMI, legal fees and the cost of reports about the condition of the land and building.
There are also additional costs after you have purchased the property. For instance, repairs and other maintenance costs, land tax, and the costs associated with real estate agents.
And finally, when it comes to selling the property you will incur further costs of real estate agent fees, legal fees and advertisement of the property. All of these additional expenses are all tax deductible, and help reduce how much tax you pay on your income.
While these other financial considerations are important to keep in mind, the benefits of investment often outweigh the costs. In many cases, the above financial costs can be easily offset by the financial gains you make by paying less income tax. You net even more after you sell the property.
Why Land Investment?
As we have already demonstrated, the financial gains that can be made through land investment are substantial. However, the question that remains is: why land investment?
There are many other types of investments that can reduce the amount of annual income tax you are subject to pay. However, investment in property and land is comparatively stable. This is because the property markets are significantly less volatile than other types of investment.
Another advantage of land investment: it is a physical investment. Many people invest in stocks and shares, however, there is something reassuring about investment in land and property. Knowing that your investment is a physical entity rather than a number on a computer can be comforting for many people.
Compared with many investments, this kind of investment does not require any special knowledge. Some of the more complex financial investments are very confusing. Almost anyone can understand how property investment works.
If you have any questions about land investment or other related topics, we’d love to help. Get in touch with us today!