April 26, 2019: Reader Feedback on Granny Flat Economics

Boredom Warning: anyone who does not have a financial interest in real estate may find the following incredibly boring!

In our last Newsletter, I wrote a short article about the financial benefits of Granny Flats versus Single-family houses.

In response I received the following feedback from a reader named Trevor:

‘Reading this article I realise you have not sought financial advice. Your example of the house in Russel Island does not take into account a depreciation schedule which depreciates the building costs each year on your tax and also all the interest on the home loan can be offset against your income. These things along with all costs associated with the property would make the property negatively geared (probably around $20000) and result in a very large tax refund.This would make the overall property returns much higher than you quoted. This would also apply to the granny flat if it was rented. With the right financial advice rental properties can be a great investment and completely cost neutral to the owner with the use of gearing.’

Trevor makes some good points about depreciation and negative gearing that are well worth considering depending on your own goals and financial situation. However, in my own defence, he is incorrect in saying that I have not sought financial advice. I have, but I readily admit that I am no financial expert and I am keen to learn more about the ins and outs of property investment.

Regarding depreciation… as I understand it (and I invite Trevor or any reader to correct me if I’m wrong here), depreciation can be used to increase the amount of deductions an investor can claim against rental income, thereby reducing the short-term profit (and the taxable income) from an investment property. However it will also reduce the Cost Base of the property which means the investor will have to pay more in Capital Gains Tax (CGT) if and when they sell the property.

Since the CGT payable is reduced by 50% if you have owned a property for more than 12 months, you’re probably better off claiming depreciation and paying less income tax now rather than not claiming the depreciation and hoping for less CGT in the future. If anyone can tell me for certain I would greatly appreciate it.

Regarding negative gearing… in order to benefit from negative gearing an investor needs to:

  1. Be willing and able to borrow money in order to claim the mortgage interest as a tax deduction
  2. Be happy to make a loss on their property investment in order to use that loss to reduce their taxable income from other sources (and thereby reduce their income tax payable)
  3. Have a tax burden that they want to reduce (otherwise they have nothing to claim the loss against).

For many (if not most) property investors in Australia, all of the above will apply and negative gearing may well be worth considering. However for my wife and I things are a bit different. We are not willing to borrow money from a bank and we certainly don’t want to make a loss on our property investments just to reduce our income tax (which is not that high).

I would very much like to hear from any readers who are experts in the property investment field as to exactly how depreciation and negative gearing can affect the net rental returns for both houses and granny flats. I’m pretty sure that the answer will be that granny flats still offer a much better ROI than single-family houses or apartments because the fundamental advantage of a granny flat remains the same… i.e. the land is already paid for.

p.s. I’d also be interested to know how CGT is calculated on a granny flat if someone owns their own home, builds a granny flat on the same property, rents it out, then eventually sells the property.

All further feedback is most welcome.

Thanks, Andy

 

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