“All of my maintenance is a tax deduction”
Although it would be nice to have anything you spent on your property to count as an immediate tax deduction, unfortunately the ATO does not see it this way. Generally speaking, the rule when it comes to maintenance on an investment property is that anything you spend to repair and/or return the item to its original condition is an immediate deduction in that financial year, whilst most things that improve the property are able to be depreciated.
To illustrate with a simple example, if an air conditioner breaks down in your property and you have a technician repair that same air conditioner, the cost of that maintenance will be deductible. If the technician is unable to fix it or you decide to replace it in its entirety, the cost of a new air conditioner becomes a depreciable tax deduction and is counted towards the Division 40 Plant and Equipment discussed in Part I of this article.
Sometimes, it’s actually better to simply replace the item and depreciate it. Not only will the depreciation deduction be reasonable in that year anyway, but it may save you money on future maintenance if it’s an aging item.
You must be careful though as not all maintenance items that are perceived as immediately deductible necessarily fall into that category. Painting your house is a good example. If you paint a few small sections where the paint is flaking off, this would be an immediate deduction. However, if you paint the interior of the house in its entirety, the ATO may view this as improving the property and it actually forms part of the building allowance. What this also means is that it may have CGT implications at sale time. It’s not all bad though as you are still entitled to yearly deductible amounts in the meantime and a repaint will also add value to your property and usually increase the rental return too.
Overall, you should check with your accountant to make sure whatever you’re spending is attributed to the right class of deduction as you don’t want to be making adjustments (and possibly paying penalties) if you are audited by the ATO at a later date.
“Not having a cash buffer”
As with anything in life, it’s good to have a little spare cash on the side to plan for unforeseen circumstances. Although in the case of an investment property, you should sort of expect the unexpected. There are two types of unexpected:
- The planned unexpected e.g. vacancy and re-letting costs at the end of a lease that may or may not happen, or the replacement of a hot water system (you know you’ll have to replace it at some point, but you don’t know exactly when).
- The really unexpected.
So what is the really unexpected?
As has already been discussed, the life blood of your property investment is the cash flow. You can insure against a number of events, but some things you just can’t plan for. What we mean by this is that unless there is a distinct delineation between your personal finances and your property finances, there is always a chance that you may come under some pressure at some stage over the life of the investment if either one comes under fire.
For example, if you lose your job and your income is supplementing the mortgage payments on your investment property, you will immediately have a cash flow problem. Vice versa, if you have a significant amount of personal bills due and out of the blue you are faced with an expensive maintenance item not covered by insurance, you’ll be under pressure.
Having a cash buffer kept aside for these sorts of eventualities is like an accumulator in a hydraulic system. It helps to smooth out the bumps and keeps things running when the demand on your cash flow rises. Remember, it’s spare capital for a rainy day designed to buy you time to make decisions without being under duress – not necessarily to completely solve the problem completely. So, if you have to use it for another reason then make sure you build it back up again once things return to normal as you will almost certainly require it again at some point.
As a guide, it is a good idea to keep at least three months’ worth of mortgage payments plus an additional $2,000 for maintenance. The $2,000 will generally cover the more common short term expensive replacements/repairs that are needed i.e. hot water system, a reasonably large plumbing or electric job or other small to medium items that may not be covered by insurance. Every investor has different personal and property expenses so this amount may vary from investor to investor.
Other routine maintenance that is non-time critical such as repainting or carpet replacements should be planned for separately. If you own multiple properties, the probability of all this happening at the same time is diminished so it’s not a case of simply multiplying it out. You should carefully assess your cash flow requirements and set a cash amount that is suitable for your personal circumstances. You can either set your cash buffer as a “hard deck” in your personal bank account – but obviously you have to be disciplined with your spending – or simply have it in another account altogether. Either way, you should view it as a mini-insurance policy and as with any insurance, if you can’t afford it then you can’t afford to invest.
“I have analysis paralysis”
This is the person who has the best intentions and actually goes out and does the required amount of work and due diligence on a property to ensure it’s going to be a solid investment. The problem is that they just keep looking for what can go wrong, rather than what can go right.
When it comes to a market or individual property analysis, there is almost no limit to the number of items you can study, research and scrutinise. What you need to realise as property investor is that as an asset class, property is generally quite forgiving. Provided you have chosen the right area through research, cover the big-ticket items with the property itself and have a solid understanding of your target market, you are more likely to succeed over a cycle.
By no means are we suggesting that you will get away with everything and obviously the more work you put in, the less likely something will go wrong. However, there is always a trade-off. There is no point in putting in so many hours of work on a single property that you never reach the negotiation phase with because it sold before you had a chance. Worse still, in a rising market, the longer you leave your purchase, the more like that at some point the growth will outstrip your budget or your ability to save to increase it. Imagine those people who procrastinated buying a property in Sydney in early 2013?
The best way to overcome this is to write down a list of “must haves” and “nice to haves”. Do not negotiate with yourself on the items on the “must have” list that you believe are crucial to the success of the investment. However, be reasonable when sacrificing items on the “nice to haves” list. There is no such thing as a perfect property as there will always be something that isn’t quite right. The most important thing to realise is that for the most part, you can always change the property itself but you can never change the location.
At some point, you will have to bite the bullet and sign a contract. Don’t let analysis paralysis get in the way of your long term financial success.
Summary
The most effective way to avoid mistakes and overcome misconceptions – and by default to enjoy greater success – is to become educated. Becoming educated properly will help you to employ the right professionals and to obtain the right advice. You don’t have to know it all, but you will only be able to differentiate between those providing sub-standard advice and the true professionals if you have a certain level of education before you do anything else.