As tax time approaches, property investors across Australia start turning their attention to ways they can maximise deductions and minimise their tax bill. Two important tools that can help are pre-paying interest and reviewing your depreciation schedule. But when do these strategies make sense? And are they right for your situation?
It is important to chat with your accountant and any financial decisions should align with your personal goals and objectives.
The below is a quick explanation of some common strategies used by investors at this time of year.
What Is Pre-paying Interest?
Pre-paying interest means paying the interest portion of your investment loan in advance, typically covering a 12-month period, rather than paying it month-by-month.
It’s most commonly done in the lead-up to the end of the financial year, allowing investors to claim a full year’s worth of interest as a tax deduction in the current financial year.
The Pros of Pre-paying Interest
1. Tax deductions now, not later
By bringing forward your interest payments, you can claim the entire amount as a deduction that year. For investors with a higher income or larger tax bill this financial year then what is expected next year, this can be an effective way to reduce taxable income.
2. Cash flow planning
Knowing your loan’s interest has been paid for the next 12 months can provide welcome certainty for financial planning and budgeting.
3. Potential savings if interest rates rise
Some lenders may lock in a fixed rate when you pre-pay, offering protection against future rate hikes.
The Cons of Pre-paying Interest
1. The upfront cost
You’ll need to have the funds available to cover an entire year’s interest in one hit. For many investors, that’s a big ask.
2. Not a year-on-year strategy for everyone
While pre-paying interest might make sense in one financial year, it can reduce deductions for the following year. That’s something to keep in mind if your income fluctuates.
3. Limited flexibility
Prepaying interest usually means locking in a fixed rate, so you won’t benefit if rates drop. It can also limit your ability to make extra repayments, and early loan repayment may trigger break fees. Be sure to check your loan agreement with your provider.
Why Consider Pre-paying Interest?
This strategy can be especially helpful for:
- High-income earners expecting a significant tax bill,
- Investors with surplus cash available before 30 June, and
- Those seeking budgeting certainty over the year ahead.
However, it might not suit:
- Those on lower incomes who may benefit more from spreading deductions over time,
- Investors who may want to refinance or sell in the near future, and
- Anyone without the liquidity to comfortably make a large upfront payment.
It’s suggested to speak with your accountant or financial planner before pre-paying interest. They can help you assess whether this strategy aligns with your overall financial plan.
What Is Property Depreciation?
Property depreciation refers to the natural wear and tear that occurs over time on a building and the assets within it. Just like a car loses value the moment it leaves the showroom, your investment property also declines in value. The Australian Tax Office (ATO) allows investors to claim this loss as a tax deduction.
There are two main types of depreciation you can claim:
- Capital works (Division 43): This covers the structure of the building itself, including walls, roofs, doors, windows, and permanent fixtures such as kitchen cabinetry and bathroom fittings.
- Plant and equipment (Division 40): These are removable or mechanical items like carpets, blinds, air conditioning units, hot water systems, and appliances.
In many cases, depreciation can result in thousands of dollars of deductions each year, especially for newer properties or those that have undergone recent renovations.
What Can You Claim?
The amount you can claim depends on a few key factors, including the age of the property, its construction cost, and any renovations or improvements that have been made.
Here’s what’s typically claimable:
- Structural improvements (e.g. extensions, new bathrooms, decks).
- Renovated kitchens or bathrooms, even if done by a previous owner.
- Internal fittings (e.g. ceiling fans, light fittings, curtains).
- White goods (e.g. dishwashers, ovens, washing machines).
- Flooring and window treatments.
It’s important to note that while new plant and equipment items can be claimed, taxation rules limit deductions for second-hand assets purchased after 9 May 2017. An accountant or quantity surveyor can help you understand what applies in your case.
When to Get a New Depreciation Schedule
Here are some key times when it’s worth getting a new schedule or updating your existing one:
1. After Renovations or Improvements
If you’ve recently renovated your investment property, you could potentially unlock thousands of dollars in additional deductions to claim. But you won’t know unless your schedule is updated.
It’s suggested to keep records of all work done and costs incurred. This information is vital when it comes to adjusting your depreciation estimates accurately.
2. After Purchasing a Property
Whether your investment is a new build or established, it’s smart to have a depreciation schedule prepared early on. Even older homes can hold substantial deductible value, particularly in plant and equipment.
3. If the Property’s Use Has Changed
Started living in the property yourself? Or maybe you’ve switched from long-term tenants to short-term accommodation, or vice versa? These changes can affect what you’re entitled to claim.
Your depreciation schedule should reflect how the property is being used. Otherwise, your deductions may pique the interest of the ATO.
How Much Does a Depreciation Schedule Cost?
A professional schedule, prepared by a qualified quantity surveyor, usually costs somewhere between $400 to $800. This fee is also 100% tax deductible. Most schedules will cover the entire effective life of the property, usually up to 40 years. This means your depreciation schedule can be used year after year, given it is up to date.
Wrapping Up
Pre-paying interest and updating your depreciation schedule are two powerful ways to potentially improve their financial position…but they aren’t right for everyone.
Take the time to speak with professionals to understand which strategies suit your circumstances and financial goals.
And if you’re considering buying, selling, or leasing your investment property, Penrose Real Estate is here to help.