How it all works

How it all works

The technical part explained – it’s all about cashflow

The IRD allows you to run your investment property as a business. This means that you can claim the expenses incurred against the income received for it, in order to reduce tax liability.

Depreciation is an expense that can be claimed to reduce taxable income.

Let’s have a look at an example of how depreciation can improve your cashflow:

 

Rental income of $400 /week                                                    $20,800

Less cash expenses (insurance, rates, interest, etc)                      10,000

Income before depreciation (cash in your pocket)                        10,800

Less Non-cash expense (depreciation)                                         5,000                  

Taxable income after depreciation (what the IRD taxes you on) $5,800

Using this example, you can see that the end result will be that less tax is paid on the income received once depreciation is claimed.

Note that the actual amount of tax paid will depend on the type of ownership structure that is in place for the property. Following is a brief overview of possible ownership structures.

Property is owned by an individual or a partner in a partnership.

In this instance, any gain or loss in income due to depreciation claimed is transferred through to the individual to claim on their individual tax return.

Using the above scenario as an example:

Income before depreciation (cash in your pocket)                  $10,000

Less estimated tax paid (@33% tax rate)                              -3,564

Income before depreciation (cash in your pocket)                   7,236

    Or if depreciation is claimed….

Less Non-cash expense (depreciation)                                  -5,000

Taxable income after depreciation                                        5,800

Less estimated tax paid (@33% tax rate)                            -1,914

Income after depreciation claimed (cash in your pocket)       $8,886

In this example, you gain an additional $1,650 in income for the year!!

Property is owned by a ‘Company’ or ‘Look through Company’ (LTC)

If a rental property is owned by a partnership of 2 or more people, then usually the partnership will obtain an IRD number and will file an IR7 Income tax return each year the property is owned. It is this return that will show the individuals share of depreciation claimed and the resulting income or loss so they can then claim it. (Note: Actual scenarios may vary. You will need to consult with your Accountant to obtain accurate information that is specific to your individual situation.)

Property is owned by a ‘Trust’

In this situation, any depreciation claimed, and the resulting income or loss, is retained in the trust and is not passed through to the individual.

Ring Fencing

What changes are proposed

For years, residential property investors have been able to use losses on rental properties to offset their personal tax.

Residential rental properties are often “negatively” geared. This means that the expenditure, including non-cash expenses such as interest and depreciation, exceeds the income, resulting in a loss.

The government proposes ring-fencing these losses and preventing investors from using any losses against their personal tax.

How will it work?

At its most basic, any losses will be carried over to the next income year. No PAYE refund will be issued to the investor.

The losses won’t be able to be utilised until the investment makes a profit.

Its impact on Depreciation

If the property is negatively geared for tax it will simply mean that the cashflow benefit is deferred. So it is simply a timing change.

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