ATO Approved Tax Entitlements

Question

I have had a call from Members Alliance saying that there are ATO approved tax entitlements for people who are under 60 years of age, who had bought or built investment properties, whose income is more then $72,000 per year. And who have done this to help them be self funded in their retirement. Have you any knowledge of this? Another question I have, is that for the past two years my husband has not been able to get the dependant spouse rebate because the tax form has entered my share of rental income as a gain (ATI) and not a loss. We use our refund to pay water and town rates. So this makes a big difference to us. Thankyou Christine

Answer


I had a look at the Members Alliance web site they offer wealth creation strategies and finance broking services, quite often this describes promoters of properties on behalf of developers. The risk is that they may not be truly independent and act in your interest. They may make their money from commissions they receive from the investments they sell. Of course the other side of the coin is those that don’t receive commissions charge fees which can also be a bit scary.
I think the tax approved entitlements are the benefits of negative gearing through claiming depreciation on a new home. The requirement that you be under 60 and earning more than $72,000 per year is probably more for the purposes of qualifying to borrow money to invest.
Please do not invest with these people without first getting independent advice from your accountant. Work out how much the property is going to cost you to hold per year, consider that this is a real cash flow loss and that the idea is to make a capital gain that exceeds this after tax. Good capital gains generally come from something that is in short supply not mass marketed estates. The bigger your tax bracket the better negative gearing works. Crunch your numbers very carefully. At the end of this answer I have put an extract from my next book that explains negative gearing, the tax rates are out of date but this is the only copy I have in a word format.
There is a nasty little trick when they changed the calculation of a dependant’s income from separate net income to adjusted taxable income a few years ago. The way the formula works is if you have a taxable loss then the formula starts with zero (the loss is ignored) then you have to add back your rental property loss so if all your income was a loss from a rental property it is effectively added back twice. Firstly when it is ignored and your loss set back to zero then when it is added back as part of the calculation of adjusted taxable income. This affects Centrelink entitlements too and is a disgusting cash grab from those that can least afford it. Please write to your Federal Member and inform them just how much Treasury has pulled the wool over their eyes.


From Winning Property Tax Strategies:

Now to name and explain the different ways a property can affect your cash flow and bottom line.
Negative Gearing – This is effectively running the property at a loss. The rental expenses such as interest and depreciation are greater than the rent received. This loss is then included in your tax return along with your other income, which reduces your total taxable income. This will probably result in a tax refund if you have already paid the tax on your other income.
For negatively gearing to work at its best, you should be in a high tax bracket now and feel that properties are about to increase in value.

Example of a negatively geared property:
Rental Income $400 p.w. $20,800
Less Cash Flow Expenses Including Interest 21,000
Cash flow loss 200
Less Building Depreciation 1,200
Tax Loss $1,400

At the 38.5% tax rate the $1,400 loss can generate a refund of $539 but at the more likely tax rate of 31.5% it is only $441.

Positive Cash Flow – In the example above the property is also positive cash flow because the loss from items that actually affect cash flow is only $200. The refund the loss, after depreciation, generates will exceed the $200 cash short fall resulting in a positive cash flow from the property. Properties are also positive cash flow when they are positively geared.

Positive Gearing – This is simply where the property’s rental income exceeds its expenses thus creating a tax bill.

Negative Cash Flow – Of course not all negatively geared properties are positive cash flow and that is when you need to be confident you will make enough capital gain to recover your losses. In fact it is normal for a property to have a negative cash flow at the start.
The chances of a negative cash flow are increased by low tax brackets and lack of depreciation. For example, using the scenario in the negative gearing paragraph above, if the tax payer had so many negatively geared properties that they earned under $20,000 for the whole year and it was 2014 or later then they would not be taxable anyway so the $1,400 loss would not generate any refund and they would be left with the $200 cash short fall.

So now that we have made our point that certain properties work better for certain taxpayers let’s look at how we calculate this. The following spreadsheet is available in the shopping section of www.bantacs.com.au

New Villa 31.5 tax rate

Tax Calculation
Rent per week $ 240.00
Expected Avg weeks vacant 1
Annual Estimate Rent $ 12,240.00


Amount Borrowed $ 260,000.00
Interest Rate 7.00%
Estimated Annual Interest $ 18,200.00


Rates $ 1,600.00
Building Insurance $ –
Landlord’s Insurance $ 250.00
Agent’s Management Fees $ 1,101.60
Agent’s Letting Fees $ 240.00
Depreciation of Plant & Equip. $ 1,398.40
Building Depreciation (Div 43) $ 3,656.50
Repairs and Maintenance $ 500.00
Travel Expenses $ 500.00

Taxable Loss $ 15,206.50

Marginal Tax Rate 31.5%

Tax Refund $ 4,790.05


Cash Flow Calculation
Rent Income $ 12,240.00
Tax Refund $ 4,790.05
Less Outflows:
Interest $ 18,200.00
Rates $ 1,600.00
Building Insurance $ –
Landlord’s Insurance $ 250.00
Agent’s Management Fees $ 1,101.60
Agent’s Letting Fees $ 240.00
Repairs and Maintenance $ 500.00
Travel Expenses $ 500.00

Annual Short Fall $ 5,361.55
$ 103.11 pw

1970’s House 31.5 tax rate

Tax Calculation
Rent per week $ 230.00
Expected Avg weeks vacant 1
Annual Estimate Rent $ 11,730.00


Amount Borrowed $ 250,000.00
Interest Rate 7.00%
Estimated Annual Interest $ 17,500.00


Rates $ 1,600.00
Building Insurance $ 600.00
Landlord’s Insurance $ 250.00
Agent’s Management Fees $ 1,055.70
Agent’s Letting Fees $ 230.00
Depreciation of Plant & Equip. $ 500.00
Building Depreciation (Div 43) $ –
Repairs and Maintenance $ 500.00
Travel Expenses $ 500.00

Taxable Loss $ 11,005.70

Marginal Tax Rate 31.5%

Tax Refund $ 3,466.80


Cash Flow Calculation
Rent Income $ 11,730.00
Tax Refund $ 3,466.80
Less Outflows:
Interest $ 17,500.00
Rates $ 1,600.00
Building Insurance $ 600.00
Landlord’s Insurance $ 250.00
Agent’s Management Fees $ 1,055.70
Agent’s Letting Fees $ 230.00
Repairs and Maintenance $ 500.00
Travel Expenses $ 500.00

Annual Short Fall $ 7,038.90
$ 135.36 pw


Obviously it is not worth paying for a quantity surveyors’ report before you buy, hopefully the seller will have the information you need but if not, as long as you know the square metres of the building you can get a good estimate from BMT on mail.bmtqs.com.au/TaxDepreciationCalculator.aspx

Please don’t lose sight of the true objective in buying an investment property and that is capital growth. Here we compare a Villa that is relatively new, so it has plenty of depreciation. Further, the building costs are usually a higher percentage of the value in strata plans because the land portion is so small. The other example is an old 1970’s house on a large block of land with no building depreciation and very little left on the plant and equipment but the land may some day be suitable for a unit development so it has potential for above average capital growth.

The spreadsheet shows you how to calculate just how much a property will cost you to hold if you are in the 31.5% tax bracket. Here is a summary of the results at each tax bracket for each property.

Out of Pocket Holding Costs Per Week @ 7% Interest:
Tax Bracket New Villa $240pw 1970’s House $230pw
Zero $195.22 $202.03
16.5% $146.97 $167.11
20.5% $135.27 $158.64
35.5 $ 91.41 $126.90
31.5% $103.11 $135.36
46.5% $ 59.24 $103.62

Notice how the 35.5% bracket is listed before the 31.5% bracket. This is to emphasis the fact you go into the 35.5% bracket, because of the low income tax offset, before you go into the 31.5% bracket.
These properties are not an extreme example, in fact they are taken from actual Stanthorpe properties. Do not just look at the table above and say ok I am in this tax racket so I need an old or new property.
It is not that simple, it is a guide to what sort of property you should be looking at but do the numbers for every property and it will give you an idea of whether they are priced right, for the type of property they are.
For example there maybe a premium on a property that qualifies for depreciation because the area is popular with investors. You need to make sure there is still something in it for you. After all by the time you sell the property the depreciation left will not command the same premium. We have seen real life scenarios where the investor was actually much better able to afford the older house then the new one even though the older house had development potential so would probably give better capital growth as well.
. Now if you did consider the 1970’s house to have more potential for capital growth and you have so many negatively geared rental properties that your taxable income is under $20,000 so you pay no tax. Then the 1970’s house is only going to cost you an extra $6.81 per week to hold compared with the Villa but if you are in the 41.5% tax bracket then it will cost you $40.34 per week extra to hold and then of course the capital growth may end up being taxed while you are still in a high bracket.
The table also tells you that if the house is not in a position to benefit from exception capital growth, in other words you are never going to benefit from all that extra land, then it is over priced compared to the villa no matter what tax bracket you are in.


Next invest some time in preparing yourself for the turbulence of investing. Do the what if analysis now to work out how much the property will cost you to hold, after tax, if interest rates increase or you have more than 1 week’s vacancy. Know just how far you can afford to go. For example if the interest rate, in regard to the two properties above, increased from 7% to 8% the table would look like this.

Out of Pocket Holding Costs Per Week @ 8% Interest:
Tax Bracket New Villa $240pw 1970’s House $230pw
Zero $245.22 $250.11
16.5% $188.72 $207.25
20.5% $175.02 $196.87
35.5% $123.66 $157.91
31.5% $137.36 $168.30
46.5% $ 85.99 $129.34
Maybe after tax, interest rate hikes aren’t that scary. Again this depends on your tax bracket. In the zero tax bracket the villa will cost you an extra $50.00 per week to hold at a 1% interest rate hike were as in the 46.5% bracket the difference is only $26.75 per week, thanks to the ATO’s contribution. Consider that it would probably take 4 rate rises to increase the interest rate by 1% which should give you time to increase the rent. Also take heart that interest rate increases are generally a reaction to inflation so while they maybe hurting your cash flow odds are your wealth has already increased by a far greater amount.
If things get too tough consider even borrowing against this increased equity to get through, what will always be a temporary fluctuation in interest rates. Selling in a panic because of an interest rate hike is not really a practical option. Do the numbers you will find the selling costs alone will cover the increased interest charges for many years. Let alone the buying costs like stamp duty should you later decide to get back into the property market.
If you would like to get further into calculating your expected return on a property, have a look at the number cruncher in the annexure. It will take you all the way through the process including the tax effect of writing back depreciation on sale and give you a minimum percentage growth required to break even. This is also very useful when you are comparing properties in very different areas as it brings the equation down to one comparable figure based on the capital growth potential of the individual area.

Myth Buster
The higher the depreciation to better the tax benefits.
This may work if you are in a high tax bracket but you need to crunch the numbers to be sure. If you are in a lower tax bracket an older property with less depreciation may provide you with a better overall return through capital growth if the land is in short supply. Your lower tax bracket will mean the depreciation be less effective in the property’s cashflow and the capital gains may be taxed at lower rate.

Improving The Cash Flow (Affordability) Of A Property
Spending money on a property will not improve its chances of being cash flow positive unless there is a corresponding increase in the rent, only non cash flow deductions will. Most tax deduction cost you money. For example if you spend $100 repairing the fly screens the ATO is at best only going to give you $46.50 back, for most people it will only be $31.50 that the ATO will contribute. So if the fly screens didn’t really need repairing you have just wasted at least $53.50.
The simplest way to own a cash flow positive property is to put down a large deposit. As a result your loan will be smaller and the interest expense is less. Without any tricks the property can become cash flow positive and support itself.
This should not be done if you have any private debt because the interest on your private debt is not tax deductible yet if you borrowed more for the rental property all of that interest would be deductible.
Typically, taxpayers start to think about investing once they realize they have some equity in their own home even though the debt is not fully paid off. The bank may want a 20% deposit to allow them to purchase a rental property or putting it another way the bank may only lend 80% of the purchase price of the property. Instead of saving up that 20% deposit the taxpayers could use the equity in their home as additional security so that the bank will lend them the whole of the purchase price plus costs.
Home units or properties in decentralised areas are more likely to produce a positive cash flow. This is because you don’t get any depreciation on the land so the smaller the portion of the value of the property that applies to the land the larger the portion that will be subject to depreciation. Be careful when a property is in a decentralised area and positive cash flow. This is probably because the capital growth is not expected to be that good. While it is great to have a property paying for itself you have to consider the equity it is tying up. The 20% deposit you borrowed against the equity in your own home to buy the decentralised property maybe better off working for you somewhere else. It is all about the opportunity cost of the money you have available to work for you. Unless that is infinite then you must look at the whole return on a property just not the cash flow.

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