Are you self-employed with more than 20 per cent equity in property? Would you pay $1,500 more tax to achieve $100,000 capital growth over 10 years? inSynergy’s Managing Director, Richard Sheppard explains.
When it comes to tax time, most accountants will focus purely on reducing your taxable income, without thinking about how this may fit into long-term investment strategies.
While this may save a few thousand dollars this year, it can be terrible for long-term wealth creation and in many cases you should be doing exactly the opposite.
There are usually many things an accountant can legitimately do to reduce your taxable income to reduce your tax payable, however this will usually also reduce your borrowing capacity.
If you have enough cash or equity to invest more, but not enough borrowing capacity, there are probably a number of legitimate things an accountant can also do to increase your income for borrowing capacity purposes.
Sometimes this may increase the tax you have to pay however if you use the extra income to increase your borrowing capacity and invest in more property, the extra capital growth of that property should be substantially more than the tax payable.
That said, there are also usually ways to increase your net business income while not paying any more tax, or very little extra.
Business income and borrowing capacity
A good investment finance mortgage broker can generally, for every additional $10,000 in income, increase your borrowing capacity by around $100,000 for a good investment property.
Of course, you can’t buy a good investment property for $100,000, but if you have borrowing capacity for say, $400,000, then an extra $100,000 borrowing capacity will allow you to buy a $500,000 investment property instead.
If you have invested in a good area that is achieving capital growth of 10 per cent or more, then that extra $100,000 of property should have helped you make an extra $10,000 of capital growth most years.
Over 10 years, that may help you make around $100,000 or more plus compounding, which may be enough extra equity to invest further.
Tax rates explained
The maximum extra tax you will pay on that additional $10,000 business income is $4,700 if you are earning $180,000 per annum or more and on the highest tax rate of 47 per cent. And if your taxable income is lower, then the extra tax is obviously also lower.
You will usually only need to increase the net income of your business for one or two years to increase your borrowing capacity.
So at worst it should be two years of $4,700 extra tax, to increase your borrowing capacity by $100,000, to help increase capital growth by around $10,000 per annum for 10 or more years.
So that might be $9,400 more tax total to make an additional $100,000 over around 10 years!
Mixing in superpowers
Paying extra superannuation usually reduces your tax, but with the right lenders will not reduce your borrowing capacity!
This is one way a good accountant may be able to reduce your tax without reducing your borrowing capacity.
Superannuation contributions are usually taxed at 15 per cent, so if you increase your net business income by $10,000, but pay that into super, you may pay as little as $1,500 in tax to increase your borrowing capacity by $100,000 and make an additional $100,000 in 10 years. That’s a great return in anyone’s books!
Even if the property’s capital growth rate is a low as 5 per cent, the return is still excellent. Or you may use some of the extra borrowing capacity to borrow more funds for a buffer to help reduce risk.
It is definitely worth discussing with your accountant and broker before you finalise your financials and tax return.
Important Note and Warning: This information is general in nature and should not be considered personal tax advice. We highly recommend you discuss these concepts with your accountant, property investment adviser and investment finance mortgage broker jointly to ensure any considered concepts are suitable for your personal financial situation, as one effect of the concept may negatively impact another part of your plan.