The financial year has ended and we're now smack bang in the middle of the crazy tax season.
Blogger: Kevin Lee, Smart Property Adviser
Some organised Aussies have already lodged their tax returns and some even have their refunds.
For us investors though, our tax return is more complicated (unless you're well prepared) and for those negatively geared investors, I hope you don't suffer too much of a loss this year. Did you know that in 2011 (the latest stats available) approx 1.76 million property investors claimed $13.2 billion in losses due to negative gearing?
A common misunderstanding of property investors is that "whatever you lose on a rental property is what you will receive as a refund in your tax return". This isn't true – your losses are tax deductions; they reduce your taxable income by the same dollar figure.
Let's look at a very simple example: John has a $180,000 PAYG income before taking into account his 'great' little investment property – which costs him $13,500 a year to 'support'. John doesn't get a $13,500 tax refund; instead his taxable income reduces to $166,500 – so he'll pay about $5,400 less tax.
Leaving him around $8,100 out of pocket. Warren Buffett famously said once that 'Rule No. 1 is 'never lose money' and that rule No. 2 is 'don't forget rule No. 1'
Sadly most Aussie investors don't understand this salient point – the great majority have just one investment property, and that's often because the negative-gearing strategy they blindly followed actually stops them from purchasing their next and subsequent properties. Hardly the strategy they'll need in order to achieve that goal of financial freedom!
Many Australians will use their tax return to buy a new television, some toys for the kids or even toys for themselves. The reality is though, that you don't really need that 'thing' do you?
As an investor, here are three smart ways to use the funds from your tax return:
1. Pay off one or more of your credit cards.
I often urge people not to fall into the ‘End of Financial Year’ (EOFY) marketing trap and feel the need to buy something new with their tax return because the item was on 'special'.
Your excess cash should really be put to better use – like paying off your credit cards.
Did you know that in Australia we currently have a combined credit card debt of $50.1 billion? That's the amount that we're paying interest on – the amount we can't or don't pay off each month!
Want that in plain English? That's $2,140 for every man, woman and child in Australia.
The five biggest mistakes people make with their credit cards are:
1. Often make late payments
2. Exceed their limit
3. Over-use their card/s
4. Make only the minimum payment
5. Don't pay the card down to zero every month
Most people understand and quite often ignore mistakes one to three, but not many people fully understand points four and five and how damaging these can be to your financial future.
Let me explain: if you don’t pay off your credit card/s balance in full every month so that you never, ever pay any interest, when you apply for a loan the bank's credit calculators multiply your total limits by FOUR and deduct that figure from your borrowing capacity.
So if you’re a ‘couple’ with a combined card limit of $38,000 and carry over some debt each month, then $152,000 gets ripped right out of your borrowing capacity.
2. Make use of an offset account on your owner-occupied loan
Use your tax return to save yourself interest on your home mortgage first. Interest is charged daily, so placing your extra funds into an offset account against your owner-occupied home loan will reduce interest charges. The more cash you leave in this account, the more interest it will save you.
Offset accounts lower the interest charged on the loan, but still deliver you leverage if you're able to accumulate all your spare cash in it. This is how an offset account works with interest only loans:
(The loan balance - Offset Account balance) × current % ÷ 12 = monthly repayments
Money in an offset account lowers the monthly repayments – a sigh of relief if you're struggling with the week-to-week costs.
3. Invest in your financial education
What can I say here? The statistics below are so, so wrong!
1. In Australia right now, the average "packet-a-day" smoker spends about $6,570 a year on cigarettes (at $18 per pack)
2. With an annual spend approaching $8 billion it's no wonder then that 11 per cent of smoking households report they're in severe financial stress; let alone their health related issues
3. To round out the picture: in 2012 alone, Australians spent $14.1 billion on alcohol!
4. And $20 billion on gambling
What the hell are are we doing to ourselves? Our burning desire to service our bad habits is costing us billions of dollars. Imagine the difference if we spent that amount of money on our financial education!
A recent article I wrote showed statistics from an ASIC survey that identified people aged between 18-24 as being amongst those with the lowest levels of financial literacy. Today these people are 24-30 years old and it's this age group that are preparing to buy their first home, start their own business or even invest in property.
Now that we're well and truly into the new financial year, you have the opportunity to make better decisions with your money.
Maybe it's time to invest some money into your financial education?
Each of us has exactly 24 hours in a day, or 1,440 minutes. No more and no less. So do Sir Richard Branson, Bill Gates and Warren Buffet. How we waste, spend or invest that time determines the level of success we have … both physically and financially.
TIP: When you invest in your education, be careful who you obtain your financial and/or investment education from; there are plenty of sharks out there. A good financial education helps you see through the ‘smoke & mirrors’ to identify the sharks ...
About Kevin Lee
Kevin Lee is the property investment expert and buyer's agent at Smart Property Adviser.
Kevin specialises in helping investors identify and acquire positive cash flow properties that generate high rental returns, enabling his clients to grow their portfolios.
Kevin's free report "How To Turn Your Negatively Geared Property Into A Positive One In 3 Steps – Without Selling" is available at www.smartpropertyadviser.com.au.
About the Blogger
Kevin Lee of Smart Property Adviser is regarded by many as Australia's most trusted property investment adviser. Since 1999, Kevin's been the go-to-guy for people when they need honest finance and property investment advice and guidance.