How ‘Tax Deductible’ Savvy Are You?

Hi David,

Happy New (Financial) Year! Very soon you will be receiving that annual document that shows what you earned for the last financial year and how much tax you paid.

Most people who did not have a Spending Plan or a Budget for the last year will most likely say something like ‘Where did all that money go?” when they see what they earned. Most people will then shake their heads at the amount of tax they paid.

It will then be time to start preparing for your income tax return and most of us will head off to an accountant or a tax agent to get assistance in filing our return. Will you have any deductions this year?

In the recent Federal Budget it was announced that small business owners could write off capital (large) purchases of up to $20,000 per item as an immediate write-off rather than having to depreciate them over time as had been the case for more expensive items prior to that announcement.

It is my belief that everyone should have their own business. 20 years ago it would have been difficult for that to be possible, but in the internet age everyone of us could be online generating additional income providing some kind of information or product or service that we have a skill and a passion for.

When you are in business the expenses incurred in generating that income are generally deducted from the income you generate to work out how much profit you made and therefore how much tax you should pay. In the case of purchasing a large piece of equipment that will last for years (such as a vehicle) you normally spread the cost of that purchase over a number of years when it comes to tax deductability.

A business owner I was talking to was considering purchasing a vehicle for $20,000 for their business because of the rule change announced in the budget and when I started asking a few questions I realised they really had no understanding of what this $20,000 ‘capital write-off’ actually meant.

They basically thought they would get the $20,000 back when they did their next tax return. Luckily I got to put them straight before they went ahead and spent the money.What is the real benefit?

Work UteSo this made me wonder how many small business owners actually understand what being able to write off a larger (capital) item really means to them financially.

Since the announcement in the budget, if you purchased equipment for $20,000 and that equipment was 100% for business use then you could subtract that expense off your income for the current financial year.

In the example of a company where the tax rate is 30% this means that you would actually get to pay $6,000 less tax that year than you would if you had not purchased the equipment. It only cost you $14,000 in real terms.

Prior to the recent budget you would have depreciated that equipment over a number of years and received a much smaller discount off your tax payable for each of those years and the amount would decrease each year as the value of the equipment decreased.

If you are operating as a sole trader or in partnership or some other business structure other than a company the percentage you could deduct would depend on your taxable income and would most likely not be 30% but the principle is the same.

Wage Earners and Tax Deductions

For wage earners there is not much you can deduct from your income before calculating how much tax you have to pay because you don’t have many costs associated with earning your income. If you use your private motor vehicle to travel between work places within a work day the distance you travel may be tax deductible.

Another expense you might be able to claim is your cost of laundry for work clothes. There is not much else!

Ask your accountant or tax agent to work out what you can claim.

Negative Gearing and Tax Deductions

Anyone who purchases an investment property is seen to be in business and as such can deduct costs associated with earning their rental income off their entire income. These costs include mortgage payments and any other ‘out of pocket’ expenses such as insurance, rates, repairs, accountant’s fees, maybe some travel costs and so on.

In a large number of cases the costs associated with purchasing and owning an investment property are higher than the rental income received. This means the property investing part of an investor’s activity is making a loss and the loss becomes deductible off their remaining taxable income (including wages).

E.g. If your ‘out of pocket’ expenses for an investment property are $25,000 for the year and your rent is $20,000 you get to deduct $5,000 off your wages (or other income) when doing your tax return. This reduces the amount of tax you have to pay and therefore can help fund the purchase of your investment property.

If your marginal tax rate as a wage earner is 30%, then you would pay less tax as a result. In this case that would be 30% of that $5,000 or $1,500 less (that’s $30 a week towards your mortgage repayments).

The Depreciation Misconception

As a property investor you will most likely have items in your property that need to be replaced over longer periods of time. Things like hot water systems, air conditioners, cabinetry, light fittings, carpets and so on.

Because replacing these items are legitimate business costs their value can be written off (depreciated) over a number of years and as such will add to your tax deductible expenses each year and reduce the amount of tax you have to pay (making those mortgage repayments even easier).

I have a real concern however that many property investors see this ‘depreciation’ deduction as free money; like they get the deduction but don’t really have the expense.

However this is a misconception. If you have had to replace a kitchen or a hot water system in an investment property you will know these are real costs and the reason you get a deduction for depreciating them over time is because they are real expenses and you need real money to pay them with when they occur.

Unless you intend selling the property before you need to replace any ‘capital items’ you need to have a plan to fund replacing these items when the time comes. Many investment property owners in this situation are relying on the property going up in value thinking they will then borrow more money against the increased value to replace these items, however there is no guarantee the property will be worth more when the time comes.

Just buying any old investment property is not a good plan and I recommend you get educated before you launch into purchasing investment properties or if you are tired of your current property investment strategy because it feels more like a ball and chain than a liberating experience!

I am one of the speakers at the Advanced Property Conferences to be held in Brisbane, Sydney and Melbourne in August and September. If you want to know more about investing in property, attending one of these 1 day events would be a good place to start learning more. CLICK HERE for more information.

If you have any questions about the tax deductibility of certain expenses you should contact the tax office, an accountant or other suitably qualified person.

Tax laws are complex and there are so many rules and regulations I could not possibly even hope to scratch the surface here but hopefuly I have got you thinking about this enough to take more interest in what goes on and maybe even think about having your own business.

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When completing your tax return make sure you claim all you are entitled to under the law but definitely do not claim anything that you can not prove or that is not legally deductible or one day in the future you may be asked to account for what you claimed and then you will be feeling very silly indeed!