The need for investors to improve cash flow
It’s only natural that investors of property regularly assess your current position financially and, in most cases, seek available alternatives that help you improve the cash flow of your property investment.
Solution
More often than not, reducing tax liability in these situations is an effective strategy for increasing cash flow.
This is based on common deductions like interest, maintenance, and depreciation on a rental property. Capital works deductions for rental property also fall under this category.
When these deductions are maximised, cash returns also increase for property investors.
Instead of letting the current year pass before claiming these deductions, you, as an investor, can reduce your tax payable throughout the current year. This can be done by utilising the PAYG or Pay-As-You-Go withholding variation.
The Pay As You Go 221D Tax Variation system is explained.
Paying-As-You-Go 221D withholding variations mean that your deductions are claimed on a staggered basis, split into intervals spread over the year. The other alternative is to get the full deduction, once only, when you prepare your annual tax return.
This method allows your employer to reduce the tax deduction rate against your wages.
The flexibility of this scheme is an advantage to property investors, who, as a result, would be able to access extra money within the year, allowing for cash flow to be managed more easily. The extra money earned can also decrease their liabilities with loans.
Depreciation’s Role
Depreciation, a non-cash deduction, is a positive catalyst in using the PAYG withholding variation method as it helps reduce one’s taxable income. Remember that this deduction can be claimed without the investor having to spend anything extra!
Investors like you can apply for this deduction by claiming whatever wear and tear your building and fixtures have that can serve as evidence of the decline in value over time. This is legal and allowed by the ATO.
To maximise this, you can organise a depreciation schedule immediately after the investment property is acquired. It is never too early for investors to maximise their returns through the Pay You Go 221D Tax Variation system.
Let us look at a scenario demonstrating the difference resulting from claiming depreciation in the first financial year, where the property calls for a typical depreciation claim amounting to $14,000. In this case, we have a two-bedroom apartment within the city that was purchased for $500,000.
Note that fees for maintenance and repair, management charges, and interest mortgage payments are all included in the annual expenses.
| No depreciation claim VS depreciation claimed* | Without Depreciation | With Depreciation |
|---|---|---|
| Purchase Price | $ 500,000 | $ 500,000 |
| Rental income (p.a.) | $ 28,600 | $ 28,600 |
| Less Mortgage (p.a. @ 6%) | $ 27,000 | $ 27,000 |
| Less Property expenses (p.a. @ 1.5%) | $ 7,500 | $ 7,500 |
| Less Depreciation 1st year | $ – | $ 14,000 |
| Tax Loss / Your Tax Deduction | $ – 5,900 | $ – 19,900 |
| An annual refund based on a 37% tax rate | $ 2,183 | $ 7,363 |
| Monthly refund if applying for a PAYG variation | $ 181 | $ 613 |
In the example, we see the difference of $19,900 annually when property depreciation is applied under the PAYG system. The property owner gains $613 in the pocket per month by claiming depreciation.
*This chart is to be used for illustrate purposes only. The above is based upon a borrower lending 90% of the purchase price, paying tax according to individual tax rates and assuming no other investments. This is a cash flow only exercise and does not consider entry and exit costs.
You Need the Expertise of a Quantity Surveyor
Applying for a PAYG variation requires you to present a property depreciation schedule that outlines all your property investment deductions in the present and the future. This is where you will need to obtain the help of a quantity surveyor.
Higher deductions in depreciation are amounts that need to be taken from an individual’s regular pay packet under the PAYG system.
Obtaining a depreciation schedule right after settlement is a smart move.
Filing for the Pay As You Go 221D Tax Variation with your accountant
Once your depreciation schedule is at hand, you will need to file a tax return at the year’s end to calculate the actual amount of tax liability.
However, note that unless approved by the ATO, your employer has no power to reduce your tax rate.
To do this, you can download a form (ato.gov.au) that allows the ATO to hear out your explanation of all your expected deductions in the coming year.
This form requires you to enter all essential information about you and your employer.
Further down the form, you will see a deduction section where you will have to fill out the interest that will be payable for you in the year ahead, along with rates and other deductions. The ATO requires this information.
We recommend you carry out this variation with your account.
Conclusion
You can pay your tax in varying amounts every month or every week.
A Pay As You Go 221D Tax Variation can improve the property investor’s cash flow; we recommend you discuss this process with your financial advisor to see whether this strategy will benefit your circumstances.