Cash flow versus capital growth

Depreciation helps you to capitalise now

All investors who purchase properties do so hoping to achieve results that will benefit them financially.

A positive cash flow scenario is generally associated with buying properties that have a high rental yield. The aim is to select a property that will receive a higher income than the outgoing property expenses; for example, interest rates, property management fees, repairs and maintenance costs.

This usually means the owner will not be out of pocket and the money left over can be used to reduce the loan faster, save for future properties or put away for personal use.

A capital growth scenario is a longer term approach, whereby investors aim to buy a property in an area with a projection for growth. Investors aim for these properties to increase in value in the long term so that when the time comes to sell, the increase in value will far outweigh the original costs associated with buying and holding the property. Sometimes these types of properties receive lower rental yields and could see the investor with more outgoing expenses than income in the short term.

No matter which scenario, there are tax implications to be aware of. In a positive cash flow scenario, any additional income earned must also be declared when preparing an annual tax return. Investors who achieve capital growth from their property must understand the capital gains implications that may apply at the time of sale.

Ensuring the maximum depreciation deductions are claimed is of utmost importance for either of these strategies.

In both scenarios, property depreciation allows an investor to reduce their taxable income so they will pay less tax.

The below example explains how depreciation deductions assisted a positive cash flow scenario. The investor purchased a two bedroom unit for $619,000 with a rental yield of seven per cent or $43,330 rental income per year. Expenses for the property including interest, rates, repairs and maintenance totalled $39,915.

BMT found $13,900 in depreciation deductions for this property in the first financial year alone.

Two bedroom unit priced at $619,000

Scenario without depreciation claim
Annual income	$43,330
Annual expenses	$39,915
Pre-tax cash flow (income - expenses)	$3,415
Cash flow position	$3,415
Tax expense (pre-tax cash flow x tax rate of 37%)	-$1,264
After tax cash position (pre-tax cash flow + tax expenses)	$2,151
Cash flow position per week	$41

Scenario with depreciation claim of $13,900
Annual income	$43,330
Annual expenses	$39,915
Pre-tax cash flow (income - expenses)	$3,415
Cash flow position (pre-tax cash flow – depreciation)	-$10,485
Tax refund (cash flow position x tax rate of 37%)	$3,879
After tax cash position (pre-tax cash flow + tax refund)	$7,294
Cash flow position per week	$140

Depreciation difference = $99 per week

Assumptions and Disclaimer

Without depreciation the investor will be required to pay $1,264 in taxes for the property. As a result, their yearly cash flow position after tax is $2,151 or $41 per week.

Simply by claiming the depreciation available, the investor’s yearly after tax scenario is improved to $7,294 or $140 per week, an increase of $99 per week. By claiming depreciation, the investor has more cash flow readily available.

To view a scenario on how depreciation will assist a property receiving negative cash flow, visit the BMT case studies page at bmtqs.com.au/case-studies.