Deductions
Deductions reduce the reportable taxable income of an entity. Deductions can be cash expenses like fees and maintenance costs, or non-cash expenses like depreciation.
In order to claim deductions proper record keeping is required, and proper assignment. Some expenditure are capital in nature which change the cost base of an asset, and may then get depreciated. While deductions only refer to the immediate taxable income reduction events.
The interest on loans for investment purposes are deductible, but the principal is not. This is because the interest is a cost of borrowing money, and the principal is a return of the borrowed funds. This is why an interest only loan is sometimes beneficial as the entire cash cost is a deduction. Debt Recycling is the process of turning a non-deductible loan into a deductible one.
Types of deductions
| Deduction Type | Examples | Requirements |
|---|---|---|
| Investment-Related | Interest, fees, advice, maintenance, land tax, property management fees, repairs, insurance | Income-producing purpose. Must be directly related to earning assessable income from the investment. |
| Work-Related | Travel, equipment, training | Work-related purpose. Must be necessary for your employment and not reimbursed by employer. |
| Business | Operating expenses | Business purpose. Must be incurred in carrying on a business for the purpose of gaining assessable income. |
| Charitable | Donations to DGRs | DGR status. Must be made to a Deductible Gift Recipient (DGR) and be a genuine gift. |
Negative Gearing
Negative gearing is a fancy name given to the situation where for a certain asset the deductions exceed the income generated by the asset. This primarily happens in real estate, but is possible for any asset where the debt rate is higher than the yield rate.
It's so common in real estate because of the non-cash cost of depreciation.
Depreciation is the slow decline of an asset's value over its useful life, and has the effect of reducing your current reportable income while increasing your future capital gains. Trading current for future tax is the act of tax deferral, and then the added benefit is capital gains are discounted at 50% so it's a tax reduction as well.
How Negative Gearing Works (Example)
| Item | Note | Cash | Non-Cash | Total |
|---|---|---|---|---|
| Rent | 3% Yield | $30,000 | - | $30,000 |
| Property Manager | 10% Rent | -$3,000 | - | -$3,000 |
| Loan Interest | 5% on 80% LVR | -$40,000 | - | -$40,000 |
| Depreciation | 2.5% on building | - | -$10,000 | -$10,000 |
| Maintenance | - | -$2,000 | - | -$2,000 |
| Land Tax | - | -$2,000 | - | -$2,000 |
| Total | - | -$15,000 | -$10,000 | -$25,000 |
If in the 47% tax bracket you would receive a refund of 47% × $25,000 = $11,750 for your loss.
FAQ
Depends on expenses and tax bracket - typically $2,000-$10,000+ annually. The savings equal your deductions multiplied by your marginal tax rate.
Expenses related to earning income, with proper documentation. This includes investment costs, work-related expenses, and business costs.
Yes, receipts required for expenses over $10, diary acceptable for smaller amounts. Proper documentation is essential for ATO compliance.
Yes, if working from home with proper documentation. You can use the fixed rate method or actual cost method. ATO guidance continually changes in this area, so it is best to refer to their site.
One of the key benefits accountants bring to your individual tax return is proper identification of deductions. It is a good idea to get personalised advice on this topic to educate yourself, and then use that knowledge yourself to avoid paying for the same advice every year.