In a tax year where fairness and equity in our property tax system was mercilessly sacrificed in pursuit of the government’s social agenda on house prices, it is as important as ever to go into the new year with a clear picture of what lies ahead on the tax front.

While changes to interest deductibility, bright-line and loss ring fencing have dominated the landscape, there are still opportunities to be found if you know where to look.

This article offers a recap on some fundamentals and commentary on the changes that will help you minimize your tax.

Fundamentally, there are only three things you must get right to ensure you are minimizing your tax liability.

1. Ensure you are claiming all the deductions you are entitled to.
2. Accurately trap and record all your expenditure.
3. Structure your affairs to ensure your income is taxed at the lowest possible rate.

By far and away the most common tax minimisation question accountants are asked is: “What can I claim?”

So, using the teach a man to fish principle, here’s the answer.

To be deductible expenditure needs to have been necessarily incurred in the production of income. This is known as the nexus test or link between incurring of cost and the earning of income.

Secondly, we must overcome the capital limitation. Capital expenditure is the cost of buying assets and improving property. For property investors it tends to fall into two categories. Improvements to building structures that go beyond repairs and maintenance: and the acquisition of stand-alone assets that are not attached to the building.

Since the removal, the right to depreciate residential building improvements has become “black hole expenditure”, neither deductible nor depreciable.

Top Tip

By contrast, individual items that are not part of the building do remain depreciable and an opportunity exists to depreciate these items given the capital limitation denies deductibility.

Now, here’s a tip. Each year review the asset schedule for items that have been scrapped and removed. The residual book value of scrapped chattel items is deductible.

Also, be alert to the low value asset threshold, currently sitting at $1,000. Assets costing less than this can be fully written off rather than capitalized and depreciated.

The final deductibility hurdle is that expenditure can’t be private or domestic in nature.

Before we move on from deductibility, we must address the removal of interest deductibility, our largest deduction.

Deductibility of interest on debt to fund a new build acquisition remains. New builds will include any property with a code of compliance certificate issued after March 27, 2020.

This will remain a key piece of information as the ability to deduct interest on new builds is set to pass between owners and will remain for a 20-year period.

New builds don’t have to be brand new buildings. The addition of a relocatable building or splitting one dwelling into two is still a new build.

If your property investment is not a new build and was acquired after March 27, 2021, no interest can be deducted after October 1, 2021.

Another quirk of the rules is that if your residential dwelling is let to an emergency housing provider your interest will remain deductible.

If your residential investment was acquired before March 27, 2021 and is not a new build, interest deductibility is being phased out on the flowing timeline.

• 75% deductible from October 1, 2021 – March 31, 2023
• 50% deductible April 1, 2023 – March 31, 2024
• 25% deductible April 1, 2024 – March 31, 2025
• Nil deductible beyond April 1, 2025

‘The final deductibility hurdle is that expenditure can’t be private or domestic in nature’

How Best To Cope

So how best to cope with this change?

The question has been made more difficult by National promising to remove the interest deductibility changes and restore the bright-line to two years if elected.

This means some investors have their hopes pinned to an election outcome that could go either way, and even if National is elected, it remains to be seen how quickly they would enact legislation to remove the rules. It’s very unlikely that any change would be backdated.

I believe the starting point is to deal with the rules we have now. Hope and prayer is never a sound basis for tax planning.

Work with your accountant this year to budget the progressive impact of the removal of interest deductibility and do it with reference to what you are likely to be paying when you come off current fixed rate mortgages.

If the cash flows associated with higher interest costs and increased taxes mean you can’t sustain your position, take action to sell and reduce debt.

If you are in business, carefully review the debt position across your entities to determine if any debt can be legitimately refinanced into business entities to reduce property debt that is losing its deductibility.

Watch Those Dollars

Answer me this: If you saw a shiny dollar coin on the footpath, would you bother to stop and pick it up?

If the answer is “yes”, then you should also bother to account for a $3 item of expenditure because with a 33% tax rate, that $3 invoice evidencing that cost saves you $1 in tax.

Adopt a business-like approach to your property affairs, treat it as the business it is. It does warrant an investment in a good accounting system.

Start by dedicating a bank account to the property-owning entity. Absolutely all expenditure relevant to that entity’s properties should flow through that entity and nothing else.

The accounting world is changing. The future involves cloud-based accounting systems like Xero that seamlessly flow banking transactions into your accounting system in the cloud where the data can be accessed efficiently.

It’s time to move on from your unreconciled spreadsheets!

Structure The Key

There is much to consider here.

Heavily geared loss-making look- through companies held predominantly by the high-income earner will now be counterproductive. Not only are individuals earning over $180,000 now paying 39%, the removal of interest deductibility will mean cash losses become taxable profits.

Trusts still offer a 33% top tax rate and the opportunity to distribute income to beneficiaries in lower tax brackets.

Be warned, restructuring companies, resettling trusts, and transferring properties to different entities can all be disposal events that trigger bright-line. Even if tax is not payable a bright-line reset now means holding the property 10 years if tax is to be avoided on disposal.

The government has announced limited rollover relief may come for transfers to trusts and look-through companies, but only if properties are transferred at cost.

Rollover relief exists now for changes pursuant to relationship property agreements, but be careful not to fall foul of tax avoidance rules when making relationship property agreements.

The movement of bright line to 10 years means many transactions that were non-speculative are now taxed and this has made traditional estate planning extremely difficult.

Ten-year bright line is the poorly drafted capital gains tax the property sector is stuck with because Labour was unable to design a fairer, more comprehensive CGT.

Be very careful relying on the main home exemption, especially with trusts. There have been multiple changes to the exemption and its application is now a tangled web of ifs and maybes.

When considering restructuring, always check the bright-line consequences, and consider whether the changes will require new lending applications. Banks are using every opportunity to re-examine lending criteria, and this is also preventing some investors from making changes that would have otherwise helped to minimize tax.