Not many property investors know a lot about land tax. I guess it’s not surprising, as the vast majority of property investors won’t pay for land tax until a number of years after they buy an investment property.
However, it’s an insidious tax in that it sneaks up on you and is at its worst (most costly) when you least need it – in retirement. The decisions about property investments you make today will determine how much land tax you’ll pay in the future. It’s definitely something you need to know more about.
An investor who acquires say a $1.5 million property portfolio (three properties) could end up with a land tax bill that reduces the property portfolios net income by 50% in 20 years. Let me explain. I have forecast that the property portfolio will produce around $99k of net pre-tax income (rental less expenses such as interest but before land tax) in today’s dollars in 20 years time. The land tax bill will be around $48k thereby reducing the investors net pre-tax income to just $51k (in today’s dollars)! That’s a lot to give to the State government when you are retired!
Lack of planning could see you suffer in retirement and perhaps regret you didn’t make more informed decisions when you purchased an investment property.
What is it?
Land tax was introduced in Australia in the late 1800’s to early 1900’s with South Australia being the first State to introduce the tax in 1884. The tax was introduced as a means of taxing the wealthy (and to attempt to break up the big estates) and raising revenue as revenue received from the sale of Crown land slowed. Each State introduced its own land tax regime (for a short time there was also a Federal regime).
Land tax is generally levied on the value of unimproved land holdings held as at 31 December each year. General exemptions exist in many States such as the exemption for your primary place of residence, land used for primary production and so on.
Revenue offices in each State generally use the councils’ ‘site value’ or ‘capital unimproved value’, which is normally recorded on a property’s council rates notice to determine the ‘taxable land value’ of each property.
How is it charged?
Land tax liability is normally charged as a percentage of the taxable land value. Some States have a flat rate and others have a sliding scale. Most States have a ‘tax-free threshold’ so that land tax isn’t payable until your land value exceeds the threshold. Most States charge different rates of land tax to trusts compared to individuals. The table at the bottom of this page sets out an overview of land tax for the major States and indicates how much land tax would be payable on $1m of land (held in one individuals name).
Why most investors will pay through the nose!
All in one name
Holding all investment properties in one person’s individual name is a nightmare for land tax. Each individual has a tax-free threshold, so spreading ownership will often reduce land tax.
Take a recent analysis we did for some clients. The clients are a married couple. Both are employees with the husband earning about $190k and the wife earning $80k. We undertook an analysis to determine the financial implications of one or both (in various percentages) owning a new investment property. They already owned other property. Intuitively, you might think that it would be better to put the property 100% in the husband’s name because he would get the highest income tax benefit. You would be totally correct.
However, we found that this created additional land tax liabilities, which fully offset any income tax benefits gained from the property, being 100% in the highest earner’s name. This is an excellent real-life example of how some people structure their investments to maximise income tax benefits today, but it will create major land tax liabilities later on.
All in one State
As discussed above, each State has its own land tax regime. Most States offer investors a tax-free land tax threshold, which means investors might be able to own one investment property in each State before incurring a land tax liability (or at least not much of a liability). Concentrating your investment properties in one State means you are not taking advantage of the tax-free thresholds other States are offering you.
My initial example in the opening paragraphs involved an investor who owned three investment properties (with a land tax bill of $48k in 20 years). These properties were assumed to all be in NSW. However, if we spread the holding over NSW, Victoria and Queensland (one property in each State), I project the land tax bill would reduce from $48k to $22k in today’s dollars – that’s less than half! In addition to this, the investor will benefit from some geographical diversification which may smooth investment returns and provide additional benefits. Investing outside you home State has great benefits.
When developing an investment property strategy, there are a number of things that need to be considered. You need to consider the market aspects – what’s available to buy, purchasing power and likely investment returns. In addition, you need to consider your own investment requirements, including things like income tax benefits, asset protection, future changes in income, exit or retirement strategy and of course land tax. The benefit of developing a long term investment strategy is that you can weigh all these things up and spread your risk at a portfolio level.
For example, if you determine that you want to hold two investment properties: an apartment and a 2 or 3 bedroom house, then it might make sense to hold the house in Victoria (one of the cheapest land tax States) and the apartment in say Queensland (as an apartment is likely to have a lower implied land value).
In another example, assuming your strategy is to hold one property in personal name and one in a trust, then you might decide to hold the personal name property in Victoria and the trust property in Western Australia (assuming both offer equally good investments). It is this type of strategic planning that can allow you to plan ahead for all considerations – land tax being one of them. Instead, most people invest in an ad-hoc manner and end up with a patch-work property portfolio that ends up being very tax inefficient.
Investment strategies cannot be tax-based
Of course, we cannot develop an investment strategy centred on minimising land tax. Investment strategies that are highly sensitive to tax legislation are not very valuable because changes in legislation can render strategies worthless. In our business, we develop investment strategies according to sound, long-term investment fundamentals. Of course, we will have regard to tax and other issues. However, the strategy won’t be totally dependent on certain tax outcomes. There are many different considerations when developing an investment strategy and land tax is only one.
Many NSW-based investors might read this article and think “the next investment property I buy will be in Melbourne because the level of land tax in NSW is crippling”. That might be a very wise strategy. However, the decision shouldn’t be made solely on land tax benefits .
Investing in Melbourne is often a sound decision, as it’s an established market that provides strong long-term returns. For this reason, diversifying and investing in Melbourne makes good sense and the lower land tax is a great side benefit. However, if after a few years, the Victorian government decided to increase land tax to the same level as NSW (they better not!), the decision to invest in Melbourne is still appropriate for the non-tax based reasons previously mentioned.
What you need to do now
If you are an existing property investor, you need to consider how your investing decisions will impact your land tax liabilities in the future. That is, you need to project forward your land tax liability in comparison to your property’s net income. You’ll be able to take this analysis into account when making future investment decisions.
If you are new to property investing and haven’t made a start yet, then you are probably in the best position to make astute planning decisions. If anything, this article should have demonstrated the multitude of considerations that need to be addressed when developing a property investment strategy. Forward planning can save many thousands of dollars!
My latest book (The Property Puzzle) takes readers through a simple 7 step process to developing their own investment property strategy. Of course, I highly recommend it! The Property Puzzle is a good start for investors to at least gain an appreciation for the process involved in developing a strategy and what factors need to be considered.
What you need to do: checklist
Analyse existing investment property holdings and forecast potential future land tax liabilities in comparison to investment’s net income
- Consider opportunities to reduce future land tax liabilities on existing investments
- Consider future investment requirements and how these plans will affect your land tax liability
- Include land tax liabilities in cash flow budgeting
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