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Discover the secrets of successful property management and investing on "The Property Investors Handbook" podcast. Join Colleen Sutherland as she shares expert insights and strategies for acquiring, managing, and maximising returns on real estate investments. Whether you're a beginner or seasoned investor, this podcast is your essential guide to navigating the world of property investment. Tune in and unlock the keys to financial success in real estate.
Produced by Pod Pro Australia
Hello and welcome to a very special edition of the Property Investors Handbook. I'm Colleen Sutherland and today I have with me my husband, Tony Sutherland, who is an accountant.
Oh, hi Tony, how are you doing? Very well Colleen,
thanks for inviting me.
I thought of inviting you today to speak about the accounting side of owning an investment property. I get lots of questions as to what I can claim, what they can't claim, depreciation, all that sort of thing. And while I know and understand a lot of it, I'm not allowed to give financial advice.
So I thought inviting you today would be a good idea just to give some people a little bit of free advice and a little bit of advice on which way to go. Fine, no problem at all. So my first question to you is, um, I'm looking at buying an investment property and other than looking around and finding an ideal investment property, what should I consider?
Firstly, you've got to consider getting advice before you do anything. Don't commit yourself before getting that advice from your accountant and a financial planner and potentially a lawyer. I'd also suggest that people need to step back and really understand why they're making this investment decision.
Because it's a huge decision. Oh, it's a massive. It's probably, after their own home, it'll be probably one of the biggest investments they make in their lifetime. So they have to get it right from the outset.
Right. And when they have found the right property, which takes a little bit of research in itself, then what do they do?
Again, it's going back to getting that advice. They need to go and speak with their, probably their accountant first. and look at who should be buying the property because it's some of the decisions they're doing are tax generated and some and obviously invest future investment generated so they need to get that advice first the and why i say that is that if they're negative gearing at all um and looking the tax breaks that come along with that They need to look at who the owner is going to be to maximise getting those tax breaks with the negative gearing.
And what do you mean who the owner should be? It's no point of necessarily a couple buying it in joint names if one, one of the couples is a much higher income earner. Then they may not be getting the full advantage of the negative gearing. But also that leads on to later on, if they do sell, who is going to be paying the capital gains tax on the sale.
Is there any way to minimise that capital gains?
Look, there's a number of ways they can do it, is looking to the current and future positions of the potential buyers, you know, whether it's a husband or wife. what their current incomes are, what their, um, likely future incomes are. But the other thing is to look at doing the structure through, say, a discretionary trust that they, um, could you utilize, and it may give them better outcomes into the future.
So a discretionary trust, does the accountant set that up or the financial advisor?
It'll be via their accountant. As accountants, we get our lawyers to set actually Establish the trust because it's a legal document, but it should be coordinated through the accountant because that then has to be registered with the ATO for tax file numbers and potentially an ABN.
And things like that. So yes, definitely through the accountant.
Right. And so once I've got a contract of sale, then do I just give them whatever entity it's to go into, whether it's my name or it's my discretionary trust, or even my super, because there's just so much trend on self managed supers.
Yes, yeah, that's the other option, but they must be aware that if they're going to purchase the property through, let's say, a discretionary trust or through their self managed super fund, they need to make sure that that trust has been established prior to signing the contract.
Oh, that's good. I didn't realise that. And once I've got all that set up, then I can sign the contract of sale?
Yes. Yes. In, after speaking to, with their lawyers first. Yes. Yes. But yes, certainly once the, uh, if, if they're doing it through one of those entities and it's established, they can then go and proceed to sign the contract.
I had a client once who bought a property in a self managed super fund, and I know that that's a whole nother set of rules. They bought it in their self managed super fund and He wouldn't do anything with it because he said, I'm not allowed to make any improvements and I can't do this and I can't do that.
What, what are the rules around that if you've got it in your self managed super fund?
Yeah, that's where it starts to get very complicated. Once it's, once you're looking to buy it through a self managed super fund, there's a whole extra set of rules that the ATO impose on that. So essentially if, uh, the super fund needs to borrow to help purchase that property, that's called a limited recourse borrowing arrangement.
And there's special rules around that. That's LRBA as we call it, that imposes some rules on what you can and can't do with that property. And getting back to what you said, you can't do an improvements, um, your client had, that's correct in that you can't do any capital improvements to the property while that loan is in existence.
Once the loan is paid out in the future, then you can do improvements, renovations, extensions, demolish it, develop it. If the super fund has the money.
So what, can you just explain to me what capital improvements are?
Yeah. Anything that versus, uh, repairs and maintenance. So obviously with any, uh, property there's ongoing repairs and maintenance, lights, dishwashers, stoves, carpets, all that sort of thing.
They're the basic repairs and maintenance to keep it in good order. in a rentable position. Capital improvements is where then you might look to do an extension on the property, further improve it substantially by putting in, ripping out kitchens and that aren't in need of desperate repair and putting in a whole new kitchen in terms of a capital
improvement.
So what if they wanted to put in An air conditioning unit that wasn't there in the first place.
Oh, that's okay. Cause that's part of, that's just a depreciable item. So it's a little bit like an ongoing repair item. They can do that because that is going to improve the rental position of the property.
Okay.
I know a property where they buy it in either their names or a discretionary trust and, uh, they want to put on an outdoor entertainment area because it didn't have one. How, how do we set that up? Is that a capital improvement?
That'll always be a capital cost or capital improvement to the property.
And if it's outside of a self managed super fund, the LRBA rules, then that's They're quite entitled to do that. Um, they just have to remember that that's not going to be immediately tax deductible in that year of the costs, because it's a capital cost versus a, uh, what they call an income costs, which is just repairs and maintenance.
So do you advise, or would you suggest that the owner of the property get a tax depreciation schedule?
Oh, absolutely. Yeah. It's um, it's, it's beneficial in the, both in the immediate term year to year as a tax deduction and it's, it's also good for future, you know, future capital gains.
Okay, so we do a lot of renovations for a unit or a house and the renovation might include replacing the blinds, painting, replacing the flooring, things like that.
Sometimes the big ticket items of the kitchen and or the bathroom. Um, with the tax appreciation schedule and I've, I've got that as soon as I buy the house or the property. Okay. What, what do I do there if I've got to make, uh, improvements on the house?
Okay, so you get the tax depreciation schedule up front when you purchase the property and that's to give you the capital allowance deduction over the overall cost of the building.
Not the land, but the building. So they, the quantity surveyors work that out. So then you get a 2. 5 percent deduction on the building. But they'll also split out capital deduction items, things like existing air conditioners, hot water services, um, you know, stoves and things like that, which you can claim higher depreciation on.
But then if you go and do further Call it improvements, you know, whether you're putting in new air conditioners, like you say, you're doing regular ongoing maintenance, things like that. It's important that the, you keep records of those. So the accountant has that. Now, if it's a capital item, like a, uh, an air conditioning unit, then they're going to claim depreciation on that over the lifetime of that particular cost of that item.
So it's important that you pass that on to the accountant in the year that you incur the costs so they can add that to the depreciation schedule.
We do an end of financial year statement and that sort of collates all the income, all the expenses and what the expenses are and that sort of thing. How important is that document to a landlord client?
Um, it's important to them because they need that record. Um, for it's part of the ATR requirements. You've got to have the documentation and the records to back up everything you're claiming. Um, but also they, uh, so, and it also helps the accountant, um, prepare the year end tax return because everything's summarized for them.
So it helps reduce the accounting time and costs. So, yes, very important that they have that each year.
And just briefly, because I know it's quite a big topic, if a landlord client has to make an insurance claim, say the tenant was in default, and they've created damage and not paid rent, and that sort of thing, how does that have an effect on their Well
again, those costs are deductible.
If it's, uh, let's say, for example, there's, um, 3, 000 worth of repairs that the landlord's got to incur to bring the property back up. Even though the tenant has moved out, it's a deductible cost because it's part of the tenancy period. If there's some sort of insurance claim or insurance recovery, that comes back in as an income item.
to the landlord. Right. So it's important that, you know, all of those insurance claim breakdown is, is spelt out for the accountant.
When I buy a property and I bought a bit of a run down property and it needs work to bring it up to the minimum housing standards that was introduced by the state government last year or the year before, I've lost track of years, that was introduced and I have to do 10, 000 worth of repairs on the house before I can rent it out.
How, how best to do that? This is
where the ATO has cracked down on that. Several years ago, when they say several, probably five or six years ago. They have their own rules now where if you buy a property and incur any major expenses, even though it may be repairs, in the first 12 months, they will deny that tax deduction.
And treat those costs as capital improvements. Their philosophy on that is if you've bought a property and it requires immediate work. in terms of repairs, major repairs. They say that you bought the, uh, the price you paid for the property reflected those, uh, need for those costs and they will deny it as a deduction in that year.
They don't, you don't lose the benefit of it ultimately because it becomes part of your cost base of the property for future capital gains tax calculations.
So do I get a tax depreciation before I do those improvements so that, you know, if I take up the carpet or I replace the air conditioner, is there any benefit on those items that I'm throwing out?
Generally not. It wouldn't make a huge difference to your tax depreciation schedule. So you might as well get the tax depreciation schedule first. If you need to do those other costs in that first 12 months, then you would do that. As long as you've got good records to pass to the accountant, so they can you.
Add that to the cost base of the property and have it on records for that future capital gains tax calculation.
So once those repairs and improvements are done, say in between tenancies, they'd get the benefit of a rental increase.
Yeah, exactly. Exactly. Yeah, it's, if it improves the property, it's obviously gonna improve the rentability and the.
income. So they won't lose the benefit of it. You just got to remember you're not getting an immediate tax benefit in that year.
Right. So then the rent is just created around the property, the state of the property in the first instance.
Absolutely.
So you've got your end of year financial statement. What will the ATO look at as in a depreciable item and items that I can claim?
Look, you've got to remember that the ATO don't look at the minute detail of every return and lodgement. It's up to the accountant to make that judgement call and get it right within the ATO's guidelines. Rental properties, uh, are one of the ATO's favourite. Um, items to look at and, and they do flag certain criteria.
So they have benchmarks that they set, you know, uh, year to year for rental properties. And if they think the, uh, repair costs is too high compared to the rental income or the interest cost is too high, they may red flag it and look, look to look at it in more detail. So it's important that the accountant gets it right.
I heard a few years ago the ATO stopped allowing a landlord to travel to his investment property, claiming the travel on to get there and have a look. That's correct, that's
correct. ATO of course they think everyone's probably a tax cheat in some form or another. So they thought, well, people are travelling from Sydney to the Gold Coast to look at their investment property, but really it's a holiday.
So they, they put a blanket ban on, generally on travel to inspect your property, particularly if you live out of state.
Look, Tony, today, even for me, has been invaluable, so I'd like to thank you for your time today and maybe we can do this again with a few more questions, ask the viewers if they wanted to pop a question in the comments, and then next time you're available to come talk to me, then I can ask you those questions.
Oh, thank you, Colleen. No, no problem at all. I'd love to come back and talk more because we touched on things like self managed superfund and purchasing property. We didn't touch on how the capital gains tax works when you sell that investment property. There's a multitude of things we can dive into.
That might be a good topic for our next podcast. Thanks so much, Tony. Thanks, Colleen.