Tips on how to minimise tax in a tighter world

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, brightline and loss ring-fencing have dominated the property landscape, there are still opportunities to be had if you know where to find them. A good place to start is to recap the fundamentals and look at what changes you could make to reduce your tax.

Essentially there are only three things you need to get right in order to minimise 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. 

Claiming all your deductions 

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. 

In order to be deductible, expenditure needs to have been necessarily incurred in the production of income. This is known as the nexus test or the link between the incurring of the 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 buildings, improvements have become “black hole expenditure” neither deductible nor depreciable. In contrast, individual items that are not part of the building do remain depreciable, which means 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 capitalised 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 27 March 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 twenty-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 27 March 2021 no interest can be deducted after 1 October 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 property investment is not a new build and was acquired after 27 March 2021, no interest can be deducted from 1 October 2021. If your residential investment was acquired before 27 March 2021 and is not a new build, interest deductibility is being phased out on the following timeline:

- 75% deductible from 1 October 2021 – 31 March 2023 

- 50% deductible 1 April 2023 – 31 March 2024 

- 25% deductible 1 April 2024 – 31 March 2025 

- Nil deductible beyond 1 April 2025 

How best to cope

So how best to cope with this change? It’s a question made more difficult by National’s promise to remove the interest deductibility changes and restore the Brightline 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 are 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. Do it with reference to what you are likely to be paying when you come off current fixed rate mortgages. If the higher interest costs and increased taxes mean you can’t sustain your position, take action to sell and reduce debt. 

If you’re in business, carefully review the debt position across all your entities. Determine whether 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! 

Structuring to ensure you pay the lowest tax rate. 

There’s a lot 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 though, restructuring companies, resettling trusts, and transferring properties to different entities can all be disposal events that trigger Brightline. Even if tax is not payable a Brightline reset now means holding the property for ten 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 ten-year bright-line is the poorly drafted capital gains tax (CGT) that the property sector is stuck with because Labour was unable to design a fairer, more comprehensive CGT. It means many transactions that were non-speculative are now taxed, which has made traditional estate planning extremely difficult.

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 thinking about restructuring, always check the Brightline 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 minimise their tax costs.