January 24, 2013 by Dymphna

Maximize Profit Without Cost

I want to talk about some very good news for real estate investors that too many just don’t take advantage of…

In fact, fully half of all real estate investors don’t use this fantastic tax reduction strategy I’m going to talk about today.  I’m going to show you how to reduce taxes without spending money.  I fully realize that most people will think about this strategy only in terms of negative gearing, but that’s a load of rubbish!

The two rules of investing

Contrary to what you might have heard, negative gearing is usually not the best way to become a successful real estate investor…. You should always invest for profit, and then figure out ways to reduce your taxes. Not to get too off topic, but I feel like I should remind everybody the two rules of investing so that you’ll keep them in mind at all times.

Investor rule #1: Never lose any money.

Investor Rule #2:  Never forget Rule #1.

Do you know who said that?

None other than the Oracle of Omaha himself, Warren Buffet.  As the world’s richest man at various times in his life, those are two rules that you might consider following very carefully…I certainly do!  So, the investing rule to follow is that we always, always, always invest for profit.

And remember–profit is what, exactly?  That’s right; it’s the money we have left over after all investment related costs and expenses have been tallied and paid for.  I don’t’ have to tell you that those expenses include the amount of taxes you pay on an investment property as well, do I?

It stands to reason that if you can reduce the amount of taxes you pay, then the greater your profit becomes!  Therefore, the smart investor minimizes the impact taxes on his or her investment properties.  That’s where this most important and very powerful tax reduction strategy comes in.

A tax deduction without spending any money

The business of identifying and claiming depreciation of property is an industry that has been legislated into existence and exists in only a few places around the world.  In fact, only three countries allow it: here in Australia, our neighbors in New Zealand and Canada.

What is property depreciation and how does it work for you?

Claiming property depreciation allows you to use wear and tear to claim depreciation against your investment properties.

Think of it this way: if you make a capital investment in a machine to make a product for your business, you are allowed to depreciate a portion of the cost of that machine each year.  It’s exactly the same concept with your capital investment in investment property.

As an owner of investment property, each year you are allowed by law to claim a year’s worth of depreciation on the costs of each investment property.  Exactly what might a year’s worth of depreciation be?  As you would expect, there are some very specific determining criteria used to calculate it, but it’s not too difficult, I promise…

But the great news is that for every dollar of depreciation that you claim each and every year, the income on which you’re taxed is reduced by the same amount!  That’s right; by simply using the law as it is written, you can reduce your taxes by literally thousands of dollars every year!   That money goes right to your bottom line and grows your profit margin.

Now consider this reality… 

Only 50% of all real estate investors claim depreciation on their real estate investment portfolio!  That means that half of the investors in Australia are kissing thousands of dollars good-bye every year!  As unbelievable as that sounds, it is the case.  Why do you think that would be?

I can only think of two reasons why real estate investors would not claim depreciation on their investment properties:  ignorance or laziness.

Neither of these are good reasons for losing thousands of dollars every year, are they?  If your accountant says, “You can’t do that,” there’s an easy fix to that problem: get a new accountant.  Too many of them simply don’t know the law or how to take advantage of it, so get one who does!

How to calculate and claim depreciation

First of all, you can’t claim property depreciation for your own home; it has to be an investment property.  Secondly, the property must have been built after 1985. Having said that, the ATO has devised the property depreciation law into distinct two sections or parts.

Part 1 of the ATO allowance for a depreciation claim on property is the capital works allowance, which is found in Division 43.  This applies to construction depreciation; you know, stuff like brick and concrete, windows and the roof.  The structural elements of a building have been determined to have a 40-year life span before needing replacement.

So, say you have a building that cost $120,000 to build and $100,000 of the construction costs was the structural elements.  You are allowed to claim 2.5% depreciation against the structural elements every year for 40 years.   That means you would get a tax deduction of $2,500 dollars every year!

Part 2 of the ATO depreciation claim on property is the parts and equipment allowance, which is in Division 40.  These are things like major appliances, i.e. ovens and dishwashers, as well as carpets and draperies.  These items wear out quicker than structural elements and have an assumed lifespan of 10 years.

Given those facts, you can claim more depreciation on them, quicker.  In our example, these items cost $20,000.  The annual depreciation claim works out to $2,000 per year every year for 10 years.  Again, that’s a direct $2,000 deduction off your taxable income every year.  And of course, the more of this stuff you have in an investment property, the more you can claim.

In this example, combining Parts 1 and 2 gives you $4,500 worth of tax-deductions every year and $45,000 over ten years!

And by the way, you can also depreciate your share of common property depreciation.

Some additional tips and considerations…

  • The older the property, the less of a deduction you will be able to claim.  That’s because in a property built before 1985, you cannot claim depreciation on the structural elements.
  • Not only will claiming property depreciation properly reduce your taxes, but also it can turn a negatively geared investment into a positive one and therefore a profitable one!
  • And, if your property is currently making money, claiming property depreciation will make it even more profitable.  Say you have a property that pays you $20 a week or $10,400 per year to own before you claim and property depreciation on it.  Again, using our example above, you can add an additional $4,500 per year to the property’s income, for an increase of over 40%!

In a more in-depth article, I’ll show you what you can do to deduct 100% of the cost of replacing appliances…Or how you can double the annual deduction on more expensive items…And why you should split some purchases between you and your spouse, among many other smart tactics.