Buying Investment Property for Tax Advantages

tax_documents

If you are lucky enough to live in a country which allows negative gearing, then this can be a great incentive to buy property as an investment.

However, you should never look to buy a property simply because it will reduce your tax bill.  Negative gearing only helps to lessen the cash loss that you make.

If you buy a property and it costs you $100 a week to hold, that is a loss, also known as negative cash flow.

You would only accept this loss if the future capital gains would cover the loss and then some!

Then with the benefit of deducting your loss, you may only be paying $60-$70/week to hold instead of $100…but it’s still a loss!

You should always try to get neutral or positive cash flow from your property, but don’t do it at the sacrifice of buying in an area that has short and long term capital gain potential.

Consider the following scenarios:

Scenario 1

You buy a property in a good area which has the potential to achieve 10% pa capital growth.  After collecting the rent and paying all expenses (mortgage interest, council rates, property management fees etc) you are $5000 out of pocket for the year.

That’s a loss of $5000!  Money spent…gone.

After claiming your tax deductions, you receive a $2000 refund.  Wow!  Thanks Mr Government for giving me this free cash!

$5000 minus $2000 is $3000 which is your actual loss for the year.  That is still $3000 down the drain.

Scenario 2

You buy a property in a good area which has the potential to achieve 10% pa capital growth.  After collecting the rent and paying all expenses, you have made $2000.

That’s income!

After adding it to your annual income and doing your tax return, Mr Government says “well we need a bit more money from you due to this extra income”.  You end up paying an extra $500 tax for the year.

$2000 minus $500 is $1500 which is your net income gain for the year.  That is money in your pocket to spend or invest in more property!

The effective result on your hip pocket is $1500 minus -$3000 equals $4500 per year.

Results?

So you can say that using scenario 1, you will pay less tax.  You can go around to your friends and brag “I just paid less tax than I should have!  Take that Mr Government” and maybe some of them will be impressed.

You will probably fail to disclose that you actually made less money this year in order to achieve it.

But scenario 2 is the clear winner because, although you paid more tax, it was simply because you were earning more money!

You actually have more in your pocket than if you had chosen scenario 1!

In conclusion, the only reason to go with scenario 1 is if the capital gain potential is more than scenario 2.  This will mean you are accepting that you are making a loss in the short term in order to get better capital gains in the long term.

This is fair enough, but it is important to understand the motivation of doing scenario 1.

The final disadvantage to scenario 1, is that if you start to build up a portfolio of a few loss-making (negatively geared) properties, all of a sudden your negative cash flow is quite high and it is now much more difficult to get finance for further properties.

However, if you have a positive cash flow portfolio, you will have increasingly more money to spend on further investments or lifestyle expenses.

Choose your investment strategy wisely.



8 Responses to Buying Investment Property for Tax Advantages

  1. You make a good point about paying taxes on the income. Other important tax advantages in real estate include interest deductions on mortgage, amortization of loan points, depreciation of assets such as buildings, and of course, the expenses that go with maintaining a property such as mileage, real estate associations and cell phones. Some of these offer tax advantages but do not affect cash flow (like building depreciation) and should be considered when buying investment property.
    The Money Ways recently posted..How to Save Money When Building a HouseMy Profile

  2. Depreciation is the most important tax benefit that property investors can claim as a deduction from their overall income and it is a generic accounting term used to describe how an asset declines in value over time.

  3. There was a time when simply investing in property was a sure fire way of making chunks of money. Now you have to be a bit more focussed and seek out advice from the experts. That is why articles like this are great, it states how you can invest and gives alternatives.

  4. Some of my clients ask me if they should declare the income from rental property. Of course the straight answer is yes, but there are a large number of tax ramifications. In the USA, the tax code is quite complex but with the excellent tax software available today, it is quite easy to run the numbers on a previous years return to test how various expenses and income data will affect your net tax position. It is very common that a net loss can be obtained for tax purposes from an actual net profit from rental returns. One of the reasons that the Southern California real estate market is so hot right now is that practically every single property purchase from a $80k mobile home to a 12,000 sq ft mansion results in positive cash flow due to super low 3.5% fixed interest rates, an incredible shortage of rentals, and very little rent control.

  5. Budapest (Hungary) seems to be cheap in terms of property prices compared to other capital cities in Central Europe. But price is not everything. Liquidity is the key point when money invested and property market liquidity is well presented in property prices of Hungary: lowe price with low liquidity.

    George Cégalapítás

  6. I never thought that buying properties or investing in properties can be this complicated. I thought it is a wise investment but it is more than that. We need to be aware of a lot of things for us to avoid negative cash flows.
    Barbara Streetland recently posted..AustraliaMy Profile

  7. After you have owned an investment property for a number of years, you are likely to enjoy substantial capital gains. Additionally, your rental income over the same time can greatly assist loan repayments to a point where it there is very little effect on your cash flow, or to the point of being positively geared.

Leave a Reply

Your email address will not be published. Required fields are marked *


*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

CommentLuv badge

Comments links could be nofollow free.