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Know All Your Tax Deductions

As I have stated earlier when you are taxed on profits you need to maximise your expenses to make your net profit smaller and thus your tax bill smaller. The catch with this is that there is smaller profit from which to build a balance sheet of assets which can provide a future passive income. It is a fine balance to manage.

What are Paper Expenses?

Some expenses are known as paper expenses (allowable non-cash deductions) as opposed to direct cash expenses, that is they are applied in the accounting. Also known as the books which were traditionally paper until computers came along.

 

Knowing all your allowable deductions for an asset or income stream will maximise your expenses and thus lower the tax you legally have to pay. Paper expenses such as depreciation are based on prior expenses that could not be fully expensed at the time of purchase. If you do claim depreciation, put the tax saving aside into an account which can be saved for the future when the asset needs to be replaced.

What is Depreciation?

Depreciation is an allowance towards the future replacement of the underlying asset. Depreciation is applied over the period of its use. When fully depreciated an item is generally at the end of its useful life. Each depreciable item has it allowance calculated by taking the purchase cost (e.g. $1,000) and dividing it by the number of months it will be used (50) resulting in an allowance of $20 per month. Tallying up all the active monthly amounts results in the total depreciation for that month. I say active as some items run out before others, or were not all bought at the same time. Also the depreciation period is set by the tax department and different periods apply to buildings (longer time), fixtures and fittings (shorter time), but not land - check your laws before including items and making calculations.

 

Carpet Dishwasher Shower Fittings Chandelier

An Example of Depreciation

For example you own an investment property that provides $1,000 rent a month and cash expenses of $800 (mortgage, utlities, fees, and maintence);

Depreciation Applies For Fixed Terms

Be careful though, depreciation is only allowed over a fixed period and will run out, therefore changing your cashflow. You will need to involve a quantity surveyor and an accountant to determine your depreciation. If in another scenario you were losing $250 a month with a depreciation allowance of $200. When this allowance ran out you could effectively increase this cash loss to $450 a month. That might make a big difference to your personal cashflow. Hopefully by this time rents have gone up, expenses have gone down and the impact might not be so much.

Beware of Negative Gearing

Negative gearing only assists by minimising losses - but you are still losing money. As I’ve said before, if you are paying tax you are earning money and not losing it - so negative gearing should be a last resort. Let me put it another way - if you are using negative gearing you are losing money, not making it.