When considering an investment property to recommend to a client, it is important, with regard to taxation, to consider the effect of tax on the income from the property and secondly, the effect of capital gains tax when the property is eventually sold.

If a client is relying on income from a property, it is important to factor the tax payable into your calculations. To do this accurately your calculations of income will need to include the client’s entire income and all deductions. Ignoring tax may result in your client gaining an income from their investment property that is much lower than they had expected. Under the PAYG system, your client may also be required to pay tax on the rental income on a quarterly basis throughout the year.

Most clients expect to ultimately reap benefits from an investment property through capital gains. However, capital gains tax can reduce those gains. It is the profit after capital gains tax that needs to be projected in estimating profit, not the profit before tax.

 

 

Activity

Peter is considering the purchase of a residential apartment in Melbourne CBD as an investment property. The purchase price of the property is $350,000. The rental is approximately $1,000 per month. Peter earns no other form of income. Assume management, maintenance and interest expenses are expected to be $7,000 per year. Peter expects to keep the property for approximately 10 years, then sell for an anticipated $500,000.

Calculate:

  • Peter’s expected annual income from the property after tax.
  • The net capital gain that Peter makes after 10 years if the property sells for $500,000 and the tax payable for that year.

(Note you will need to check the current rate for taxable income.)