How do I pay less tax on my investment properties?

Often when investors think about minimising their tax, they often think: “Isn’t it all a bit wrong, or even illegal?”

Don’t worry, in this article we aren’t schooling you on how to pay less than your fair share or pilfer from the taxman (both of which will get you prosecuted BTW).

Tax minimisation is simply about not paying any more tax than you need to. No-one wants to donate extra tax dollars to the government if they don’t need to.

So, in this article, you’ll learn about the three ways investors can minimise the amount of tax they pay, in the real world.

If you have any questions or thoughts, please leave them in the comments section below.

Full disclosure: We aren’t accountants. Its best practice to discuss any matters regarding your personal tax situation with a property accountant. Not every tactic we mention here will be appropriate for you.

So, how do I minimise tax?

It’s conceptually simple, the amount of tax you pay is: the profit you make times your tax rate.

So if you have a taxable profit of $10,000, and your tax rate is 33%, you should pay $3,300 in tax.

So, if you want to decrease the amount of tax you pay you have to decrease one or both of these things – either decrease your taxable profit, or bring down your tax rate.

Let’s explain how to do this, and who can do this, in more detail. Let’s start with decreasing your taxable income, and then decreasing your tax rate.

Decreasing your taxable income

You might be wondering: “Why would anyone want to decrease their taxable income?” After all, sure you’ll pay less tax, but you’ll also be earning less, right? Not necessarily. There are ways to decrease your taxable income – to pay less tax – without losing out.

#1 Invest in the “right” types of assets

If you’re a property investor you’re off to a good start when it comes to tax minimisation.

Why? Because while your capital gains increase your wealth – what we call “economic income” – they are generally not classed as income from a tax perspective.

So, when you invest in assets that produce “economic income” you can reap the benefits of value increases without being taxed. This doesn’t just happen in property, but in all types of assets like shares and businesses too.

Compare this to what happens if you invest in a term deposit. All the income you earn from term deposits is taxable.

So, simply by deciding to invest in property you’re minimising the amount of tax you pay, compared with what else you could have invested in. So, it’s a good start.

Note: The Bright-Line Test is the exclusion to this, obviously, but that’s another kettle of fish completely. Read our article for a full rundown of when you have to pay tax under the bright line test.

More from Opes Partners:

• What taxes do property investors need to pay? (Article)
• What is interest deductibility? (Article)
• Do I have to pay tax under the Bright Line test? (Article)

#2 Taking control of your non-cash costs

The second way to decrease your taxable profit is through claiming all of your non-cash costs.

A non-cash cost is an expense that doesn’t involve a direct cash payment, or things that you would have paid anyway.

When claimed, these will make your taxable profit lower, so that you pay less tax than you would have. But, since you pay for them anyway, your actual cashflow remains the same.

Let’s go through some examples in a bit more detail.

Chattel depreciation

Letterboxes, curtains, appliances and items that aren’t nailed down or directly a part of your property, are considered a chattel.

And over time these chattels decrease in value through wear and tear. This is called depreciation.

You can claim this depreciation as an expense to decrease your taxable profit.

For instance, if you buy a $800,000 property, you’ll probably have $50,000 worth of chattels.

If you get your chattels depreciated correctly you could potentially save as much as $16,500 in tax (over time), if on a 33% tax rate. But this varies from property to property because every chattel depreciates at a different rate.

For example, the IRD reckons your drier, washing machine and dishwasher are good for 6.66 years. But your lawnmower and your microwave are only good for 4 years. You can check out the IRD list here.

This is why it’s important to use a company like valuit.co.nz to make sure you get a proper chattel valuation and depreciation schedule, which you can give to your accountant.

Home Office Expenses

Every investor is already paying for power, internet, and rates as a part of their household expenses (if we can assume you’re not living in a cave).

The good news is you can account for some of these costs as home office expenses.

For instance, if you can claim $3,000 of expenses that you were paying for anyway, then your taxable profit is $3,000 lower than it otherwise would be.

On a 33% tax rate, that could save you $1,000 in tax.

Travel

Additionally, you can claim a portion of the travel costs you incur visiting the property to check everything is ticking over as it should, or when you go to do repairs.

You can either use the IRD's mileage rate or claim a percentage of the total running costs and depreciation.

The link for kilometre rates for 2021 is here. The 2022 rates are typically published after each tax year ends.

For all of these methods it’s again important to realise that if you don’t claim the above you overpaying your tax. The purpose of this article is to make sure you aren’t paying more than you need to, especially as more taxes are levied on investors.

Decreasing your tax rate

After reducing your taxable income, it’s now time to look at decreasing your tax rate.

Ownership structures, or how you choose to own your property, have a big part to play in minimising this amount of tax paid.

Because if you own your properties in the “wrong” way you will almost certainly overpay.

Usually, most investors will choose one of the following structures:

• Hold property in your own name

• Set up a trust

• Use a “look through” company (LTC).

Let’s go through a few examples to see how you could decrease your tax rate.

Own name → Trust

A trust is a separate legal entity, which owns assets on behalf of beneficiaries (usually you).

These can be useful for higher-income earners, since the top tax rate is 39% for any income earned over $180,000.

On the other hand, a trust’s tax rate is 33%.

So, if are a high-income earner and move your properties into a trust, your tax rate will fall from 39% to 33% (assuming you don’t immediately distribute those funds back to yourself).

This means on a property earning $10,000 in taxable profit, you could save yourself $600 in tax.

50/50 Ownership → look through company

A Look Through Company (LTC) can be extremely helpful as a restructuring tool because it takes on the tax rates of its shareholders.

By this we mean LTCs can be set up in a way so that a lower income earner can “earn” a greater proportion of the property’s profits. That way more of the income is taxed on the lower income earner’s tax rate.

Here’s a real life example of how this works with one investing couple.

In this situation, the wife is a partner at a large law firm and earns a bucket-load of money that is taxed at 39%. Her husband is a stay-at-home dad, earning nothing.

Now, if they owned their properties 50/50, half of their taxable profit would be taxed at 39%, the other at 10.5%. So all up they would pay about a 25% tax rate, when you average it out.

But by setting up a LTC all of a sudden 99% of the properties are owned by him. That means 99% of the taxable profit is taxed at a 10.5% tax rate. And only 1% of the taxable profit is taxed at a 39% tax rate. The effective tax rate is now just under 11%.

In this case if their portfolio earned $10,000 in taxable profit, they would save just under $1400 in tax every year. And that continues every ongoing year.

Owning your properties in the right entities

Streamlining your properties to be held within the same entity can help minimise your tax as well.

For instance, let’s say you have two properties. And let’s say that property A is making a taxable profit of $10,000, but property B is making a loss of $10,000.

From a cashflow perspective, it might seem like this investor is breaking even, so there’s no tax to pay.

But if the properties are owned in separate entities the investor still may have to pay tax.

Why? Even though you won’t pay anything on property B (as there was no profit), you still have to pay $3,300 in tax on property A (assuming a 33% tax rate).

In this situation, the more efficient tax structure is to transfer both those properties to the same entity – like a trust – so they offset each other. That way you have $10k coming in for one property and $10k going out on the other. There’s no taxable profit, so no tax to pay.

Do I really need a property accountant?

The key takeaway for investors here: There is a difference between the income you earn and the income taxed.

This article has discussed the main ways to minimise the amount of tax you pay.

• Decrease taxable profit through selective investing

• Decreasing taxable profit through non-cash costs

• Structuring your affairs to minimise your tax rate

But and this is a big but you won’t realise if there are opportunities to minimise your tax until you talk to a property accountant.

Any accountant can file your tax return, but it’s a very wise decision to use an accountant who specialises in property and can analyse your specific situation.

If you need a recommendation, Opes Partners has reviewed the Top 5 Property Accountants in New Zealand.