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PAYG Tax Variation Explained

One of the main reasons that residential investment property, Perth and elsewhere, has remained such an attractive investment vehicle is the way in which Australia treats tax when it comes to investment properties. Whereas in many countries you need to set up a property holding company in order to claim most tax benefits deductions from your property’s expenses, here in Australia you are allowed to directly offset the costs of owning a rental property against your own income from formal employment (as long as the expenses are greater than the property’s income).

How Does Tax Variation Work?

When it comes to residential investment property, Perth is an expensive place to own a home. However, this can work to your advantage, if you’re careful about how you manage your tax. As soon as you sign a lease with a tenant, you can then fill out a “Tax Variation” form. This allows you to deduct all expenses incurred from running the property from the income that the property earns, reducing the amount of tax you have to pay on your rental income.

If your expenses are greater than the income derived from the property – which is often the case during the first few years – you can actually deduct the excess from your own income tax liability. This is called “negative gearing”. Once you have filled out the Tax Variation Form, you can then claim the shortfall weekly or fortnightly from your employer, rather than covering the shortfall yourself and then claiming it back on your tax return in June.

Let’s look at some of the hypothetical figures:

Say you earn $100,000 a year, and you buy a rental property that gives you another $6,000 a year in income.

  • Your income tax before buying the property would have been $24,950
  • Add the property’s income, and that turns into $27,170 tax on an income of $106,000
  • However, you incur expenses of $10,000 in the first year, bringing your total taxable income down to $94,000
  • This means the tax you pay reduces to $22,930 – a tax saving of $2,020!

Now, that’s a nice saving, but where this really comes into play is if you manage to use the deductions to bring your income down into the next lower tax bracket. Generally, to do this it takes more than one investment property. Perth is a great place to buy, so why wouldn’t you want more?

If you could add another property and reduce your taxable income to below $80,000 you would suddenly be looking at a tax rate of around 24%, instead of 38%, which you could be paying if you were earning around $150,000 before tax.

What Can be Deducted From my Income?

The following expenses can be deducted from your rental income for tax variation and negative gearing purposes:

  • Interest on your mortgage (but not the capital portion of the repayments)
  • Repair bills
  • Rates and taxes
  • Property management fees
  • Legal costs relating to taking ownership and signing tenancy agreements
  • Depreciation (which can be a massive tax saver – so make sure you get your property valued every six months or annually!)

Is it Always Worthwhile Owning an Investment Property?

Perth is a great place to own investment property, but tax variation isn’t always going to be saving you money. Remember that your primary goal here is capital growth, so if your expenses from your property are wiping out your capital growth, it’s not really ever an investment that will pay you back.

A general rule of thumb is that your capital growth plus income should be double your property maintenance and depreciation expenses.

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