Simply Junior

Domestic rental property investments remain popular and continue to attract the attention of the Australian Taxation Office.

There tends to be some confusion about how rental property ownership can impact on your tax situation. With that in mind, here is a checklist of some common tax issues for you to consider (especially before you commit to buying a rental property).

If I own a rental property, am I in business? The answer to this question usually surprises people. If you simply own or co-own an investment property or even several properties, you are usually regarded by the Tax Office as an investor who is not carrying on a rental property business, either alone or with the other co-owners.

However, even if you are not carrying on a rental property business, this does not mean that you escape the tax net.

How can a rental property affect my tax?

- Acquisition and disposal costs generally are not immediately deductible (e.g., cost of purchasing the property, stamp duty on the transfer, conveyancing costs). Some of these costs may be relevant for capital gains purposes.

- When you rent out a property, the rent you collect and other rent related income (e.g., if you are entitled to retain rental bond money) is assessable for tax purposes. Against this income, you can claim deductions for a range of expenses you incur whilst this property is rented out (or available for rent).

- Where the total rental income exceeds the total allowable deductions, you will have a net assessable amount, which is added to your other taxable income. Where the total allowable deductions exceed the total rental income (this is a negatively geared property), you will generate a loss that may be off-set against your other taxable income.

- When you sell a rental property, you may need to pay capital gains tax on the net sale proceeds. You may also need to pay tax on gains made on the sale of any depreciated items that are sold with the property (e.g., where the property’s fixtures and fittings have been depreciated).

What happens if I own the property with someone else? If you own a property with someone else (co-ownership), your legal interest in the rental property determines your share of rental income and deductions.

The best place to look to work this out is the Title Deed to your property – this will usually identify what sort of legal interest you have:

- if you are a joint tenant, each of you holds an equal interest in the property (e.g., two joint tenants will each hold a 50% interest); or

- if you are a tenant in common, each of you may agree to hold unequal interests in the property (e.g., you may agree for one of you to hold a 70% interest and the other a 30% interest)

How does this type of ownership impact on my tax? If you are co-owners who are not carrying on a rental property business, you must divide the income and expenses for the rental property in line with your legal interests in the property:

- joint tenants always equally share income and expenses – you cannot vary this for tax purposes with some other agreement; or

- tenants in common share in the income and expenses in proportion to the their respective legal interests as set out in the Title Deed.

EXAMPLE John and Mary own a profitable rental property as joint tenants (a 50% interest each) and are not regarded as being in business.

Mary earns no other taxable income, so Mary and John decide it would be a good idea for Mary to receive most of the net income from the rental property and any profit on its eventual sale, so they enter into an agreement to that effect (e.g., Mary 70% and John 30%).

Because John and Mary are joint tenants, this agreement has no effect and Mary and John will still each receive 50% of the net rental income and the net proceeds on any sale of the property.

However, if John and Mary owned the property as tenants in common and the Title Deed indicates that Mary holds a 70% interest and John a 30% interest, then these proportions will usually be applied for tax purposes.

Do I have to pay PAYG on my rental income? Once you earn business or investment income (and this includes rental income), the ATO may notify you that you have to start paying your income tax in instalments (Pay As You Go (PAYG) instalments).

According to the ATO, as a general rule this installment system will apply to individuals who have shown gross business or investment income of $2,000 or more in your latest income tax return and the debt on your income tax assessment is more than $500.

PAYG instalments are usually made at the end of each quarter, but in some cases you may be able to pay an annual PAYG installment if the tax you would have paid on your business and investment income (excluding any capital gain) is less than $8,000, based on your last income tax assessment.

A very important part of personal financial planning is tax planning. This article will help you take the mystery out of personal tax Planning by providing a financial planning perspective for your overall tax situation.

1. Be aware of the different types of taxes

Many people are not aware of the different types of tax systems that we have. Income: Federal, State and Local. Real estate tax. Tax on Investments: Dividends, interest, capital gain, and passive income on stocks, bonds, mutual funds, and investment real estate. Estate or Inheritance Tax: Federal and state tax due on the estate or the inheritor. Gift tax: tax on giver of large gifts. Entitlement Tax: Social Security and Medicare (FICA), Federal Unemployment (FUTA). Sales, self employment, and corporate taxation.

2. Consider working with a Qualified Tax Professional

Tax planning can be complex for many people, therefore it may be wide to work with a trusted professional tax advisor.

Tax advisors not only prepare your taxes but can help make decisions that will affect your future. They can serve as advisors for a whole host of matters and they can represent you if you face the dreaded audit. Consider the following when selecting a tax professional:

- Local: Someone that you can easily meet with face to face

- Personable: Someone that you can interact with and who cares about you

- Proactive: Some tax preparers simply look at your previous year’s return and plug your current numbers into last year’s format. This of course assumes that last year’s preparer knew what he/she was doing. Try to find a preparer who knows your situation. A proactive professional will ask questions that will help you anticipate changes in your tax situation to help you properly plan in advance

- Reputable: Find a professional with a good reputation. Ask people you admire for a referral.

- Skilled: Look for an accountant that is very competent. You have to be smart to obtain a degree in accounting or law.

Fees: Find out up front what they estimate their fees to be, what they charge to file electronically and whether they will represent you in an IRS audit. Avoid any ‘early refund’ ploys. Some well known tax preparation companies ‘provide’ this service which charges a hefty fee (with a lot of small print) and a lot of advertised hype for you to get your refund ‘early’. It is basically a high-interest loan. Just waiting for your actual refund will save you a lot of money.

3. Remember, tax preparation entails both art and science

The science involves the mathematical calculations that in most instances can be figured using calculators and software, and the infinite number of complex tax laws.

The art of tax planning comes into play with interpretation of any special circumstances. There are some areas of tax law that leave the government’s intentions unclear. No law can completely anticipate each person’s situation. You could call a dozen different IRS agents with the same question and get as many different answers. A proactive planner will research any unusual circumstances you may have and help you plan a course of action.

4. Doing Your Taxes Yourself?

I firmly believe in getting professional tax assistance. However, I realize that many people prefer to do their own taxes perhaps to save money, or perhaps you have cleaned up the mess a ‘store front’ preparer made of your taxes and vow to do your own. It has been my experience that often the professional tax preparer has saved us the amount of their fee in our taxes. The peace of mind that the taxes are done right has a value all its own.

However, people who have prepared their own taxes at least once with paper and pencil or software usually understand taxes much better. If you self-prepare your taxes, consider having a qualified accountant review them before you send them in. They may find things you or the software might have missed.

If you made less than $54,000 in 2007, you can file your taxes electronically for free through the irs.gov website http://www.irs.gov/efile/. If you use tax software and wish to e-file be aware of the fees so that you can budget and compare prices properly. For example, a download of Turbo Tax Home and Business Federal and State for 2006 cost just under $100 and the filing fees cost around $30. Some States allow you to ‘phone in’ your State return for free.

If you choose to mail your return, go to your local post office and send it ‘Certified Return Receipt’ mail to insure that you have a record that the IRS received your paperwork. This will cost around $10 or less and will be worth every penny should the IRS contest the receipt of your return.

5. Keep great records

If you are already very organized you may read this section just to feel great about your organization skills or skip to the next section. If, however you have heard ‘get organized’ many times before and if you are the type of person who balks at the idea of organizing that mess of receipts just remember how you felt last year as tax time approached. You could become organized in only one evening of television viewing with the right tools. Arm yourself with an accordion file with at least 16 sections. Label them according to your situation or use the following sections: Auto, Bank, Business, Credit Cards, Dental, Medical, General Receipts, Grocery, Income, Insurance, Mortgage, Utilities, School, and Taxes. Now sort your receipts into these sections. Organizing your receipts will help you “Take the mystery out of…” your financial situation. Use a new accordion file every year. Not only will this help you find needed information, it will also help you find a receipt in case you need to return an item you purchased. . Your tax professional will be sending you a tax organizer the end of December or the first of January. In this organizer will be a list of information that you will need to gather. Becoming organized will help you easily gather the information you need to fill out your tax organizer.

6. Start early

Do not procrastinate on your taxes. Tax professionals are unbelievably busy January through April. Firms who prepare business returns also have a crazy March 15 business deadline. We are providing this information because we want you to get the most attention from your preparer during their craziest season. As soon as you get your organizer, begin gathering the needed papers. If you are only missing one or two pieces of information return the organizer to your accountant with a note that says what is missing. They will begin entering the information in their software. Try to get a January or February meeting with your accountant. These months are the best to meet because they will have more time to spend with you and they will be able to think proactively. If you are looking for a professional, start looking now.

Another reason to start early is allowing yourself time to look for records, ask financial institutions for copies of lost information, or calling investment companies for statements.

7. Judicious Paycheck Tax Withholding

Many people like to overpay their taxes, so that they get a nice refund in time for vacations or other wants and needs – Kind of like a forced savings. Overpaying taxes is like a giving the government an interest free loan of your money.

Good financial management involves developing savings habits so that you set aside money in an interest bearing account from each paycheck for future needs, wants and emergencies. This helps you to avoid using credit cards for those things and not having to wait until refund time. Secondly it then allows you to manage how much you can afford or are able to put into 401(k) plans at work. This accomplishes two things, first you are managing your money better and you are saving for retirement. Saving for retirement in tax deductible retirement plans like 401(k)s will also lower your taxes, enabling you to save more for retirement and everyday needs and wants.

If you want to lower the taxes that are being withheld from your paycheck, file a new W-4 form with your employer to claim an additional withholding. Make adjustment for getting married, divorced, having children and for increasing contributions to tax deductible retirement plans. Your accountant will help you estimate this.

8. Tax planning is not the tail that wags the dog

Taxes consume a large if not the largest single percentage of your income, therefore good financial planning should strive to lessen them, by whatever means possible as allowed by law.

However, tax planning is not the only core issue of good financial planning. Tax planning works in concert with your overall goals and your individual situation.