Ultimately, every dollar of tax you hold on to is an extra dollar you can use to save, invest, or spend on your lifestyle today. And it’s the only way you can make more progress without just sacrificing more or taking on extra risk.
These are the top tax deductions for high income earners.
Negative gearing
When you buy an investment property in Australia, the negative gearing rules allow you to claim all mortgage interest costs as a tax deduction against your employment income.
On top, all ongoing property costs like insurance, strata, rates, and maintenance and repairs are also fully tax deductible.
This has the ability to cut your tax bill by tens of thousands of dollars each year.
EXAMPLE: Owning a $1 million investment property will result in annual tax deductions of around $26,000.
If you’re on the top marginal tax rate it’s 47 per cent this means that you’d receive between $12,220 extra back in your tax refund each year.
And on top, you get the upside from the increase in the value of your property over time.
Claim property depreciation
If you have an investment property which is a new build or has recently undergone a significant renovation, you’re able to claim tax deductions for what’s called ‘depreciation’ costs.
This is basically the decline in value of the fixtures and fittings of your property.
EXAMPLE: Buying a brand new oven might cost you $2,000, but buying a second hand oven that’s one year old might only cost you $1,000,
Buying a five-year-old oven second hand might only be $500.
This decline in value doesn’t immediately cost you anything out of pocket - but under the depreciation rules you’re able to claim this as an immediate tax deduction.
On a newly built property these costs are commonly north of $30,000 each year, which can result in a significant cut in your tax bill.
If you go down this path it’s important you’re careful to choose a quality property that will grow in value over time.
If your property doesn’t grow, you may receive some good tax benefits in the short term, but over time you’re unlikely to actually make any money from your investment.
Borrow to buy shares or ETFs
Similarly to borrowing money to buy an investment property, if you borrow money to invest through shares you’re also able to claim a tax deduction for your ongoing interest costs.
If you’re borrowing to buy shares, where and how you do this is critical to your results.
It’s possible to do this through a margin loan or personal loan, but with these sorts of debt facilities you’ll typically pay interest of around 9 per cent, meaning your share investments need to return at least 9 per cent for you to break even - and this is a high hurdle to clear year on year.
You can also borrow to buy shares with a mortgage secured against a property, and this can work well where you have equity from buying a property that has increased in value.
When you borrow against a property, your borrowing interest costs will be significantly lower at around 6 per cent, meaning your investments need to do less for you to end up ahead.
Debt recycle
Debt recycling is a strategy that allows you to convert your non tax deductible home mortgage debt into tax deductible investment debt over time, while building a portfolio of shares or ETFs.
This strategy is a little complex, and if you’re thinking about going down this path it’s important you get some good advice to do it the right way and manage your risks.
The simple version of debt recycling is that if you have $100,000 you want to use to get ahead, you use that money to pay down your non tax deductible home mortgage.
From there you can draw the funds back out of debt and use them to invest with shares or ETFs - and because the reason you’re making this drawdown of debt is to invest, under the ATO’s rules this becomes deductible investment debt.
Given the average Australian mortgage size is over $700,000, having the interest on this debt being tax deductible can deliver you tax deductions of over $40,000 each year, resulting in significant tax savings.
Super contributions
This is a simple strategy, but one that’s highly effective.
These are also referred to as ‘concessional contributions’, and when you put this money into your super fund, you’re able to claim a tax deduction for the full amount.
It’s important to note that your $30,000 annual tax deductible super contribution limit includes any compulsory contributions made to your super fund by your employer.
But for most people, even those on a high income, this limit leaves room to make substantial contributions - and receive substantial tax deductions.
How much tax will I save?
Using each of the five strategies above has the ability to easily generate over $100,000 in tax deductions each year, and if you’re on the top marginal tax rate this means around $50,000 back in your tax return every single year.
The biggest tax mistake for high income earners
But it’s worth noting that if you’re on a very high income, even in using all of the strategies outlined above, you’re still likely to be paying upwards of six figures in tax each year.
In some ways this is a good thing, because it means you’re crushing it.
But there’s a common high earner tax mistake that results in many people paying much more tax than they should.
It comes from when high earners use their spare cash to buy up more income generating investments, things like shares, property, and even cash savings.
The issue here is that when you own these investments in your own name, all the income and gains generated by these investments adds onto your already high income, and is taxed at higher rates.
Investing is absolutely critical if you want to get ahead, but the thing here is that you don’t need to be the one to own your investments.
You can choose to invest in joint names with your partner, or under a trust, investment bond, company, or even your super fund.
When your investments are owned by another tax paying entity, and particularly with structures like trusts, bonds, and companies, the income generated from these investments doesn’t add to your personal income and isn’t taxed at personal income tax rates.
This increases your after tax return with the exact same investments.
Most people miss this because they’re too caught up on tax deductions and pumping up their tax refund, but they don’t realise they could be costing themselves more than they’re saving.
The wrap
If you want to be smart about how you get ahead, using the tax rules to your advantage will be an important part of your strategy.
There is a huge opportunity here when you’re smart with your approach. Take the time to understand the rules, and put a solid plan in place.
The rules can be a little complicated and confusing, and the decisions you make today will have a long term impact.
Ultimately your goal is to build a lot of wealth, but being smart with where you do this will make a huge difference to how quickly you make progress.
Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. Ben’s new book, Virgin Millionaire; the step-by-step guide to your first million and beyond is out now on Amazon | Audiobook.
If you want to chat about getting some help with your money, you can book a call with Pivot Wealth here.
Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.
