How is income arising from an investment in real estate taxed and can these taxes be reduced or offset in any way?
If the investor directly holds real estate, the investor will be taxed at their marginal tax rate in respect of the income received. The rate applicable (maximum 51 percent, including the Medicare levy surcharge, for Australian resident investors and 47 percent for non-Australian investors) depends on the type of investor and the amount of taxable income derived during the income year.
Income received by a company is taxed at the corporate tax rate of 30 percent after allowing for deductions.
Australian resident investors are taxed at their marginal tax rates on distributions (dividends) received from a company and offsets (referred to as ‘franking credits’) may be available to Australian resident investors for the tax already paid by the company on the profits from which the distributions are paid. Due to the availability of the offsets, effectively, Australian resident investors pay tax in respect of the distributions on the difference between their marginal tax rate and the 30 percent tax already paid by the company.
Payments of fully franked dividends (that is, dividends fully paid out of profits which have already been subject to taxation in Australia) from a company to non-Australian resident investors are not subject to further Australian income or withholding tax. Payments of unfranked dividends (that is, dividends which have not been subject to taxation in Australia) from a company to non-Australian resident investors are generally subject to Australian withholding tax of 30 percent. This withholding tax rate may decrease (to between 0 percent and 15 percent) where the non-resident investor resides in a country with which Australia has a double tax agreement.
For flow through or tax-transparent entities (such as certain trusts and partnerships), Australian resident investors are taxed at their marginal tax rates in respect of their share of the income derived by the entity. Non-Australian resident investors are subject to Australian withholding taxes in respect of certain distributions (such as, dividends and interest) and are generally taxed at their own marginal tax rates (up to 47 percent) in respect of other taxable distributions. For trusts, the Australian trustee generally withholds the tax payable from distributions made to non-resident investors. As discussed above in respect of dividends, the rate of Australian withholding tax may be lowered in respect of distributions of dividends where the non-Australian resident investor resides in a country with which Australia has a double tax agreement. Certain concessions allow distributions from qualifying withholding managed investment trusts (MIT) to non-Australian resident investors who reside in an effective tax information exchange country (such as the US, UK etc) of rental income and capital gains to be taxed at 15 percent or 10 percent if the MIT owns newly constructed energy efficient/environmentally sustainable commercial buildings. Otherwise, a 30 percent tax rate applies for distributions by qualifying MITs.
The flow through entity itself is generally not subject to taxation.
The owner of real estate may reduce or offset the taxes payable by claiming deductions for capital allowances (effectively a depreciation allowance) or interest or other related expenditure. The amount of capital allowance able to be claimed depends on the type of asset and its estimated effective life. However, the cost of land cannot be depreciated. Interest costs may also be deductible subject to the restrictions imposed by the thin capitalization rules and certain other integrity provisions (eg transfer pricing).
Further, the owner of real estate may realize losses which may be carried forward in certain circumstances, if certain tests are satisfied, to offset future income.
Rent received is generally subject to Goods and Services Tax (GST) (the equivalent of VAT). However, residential rent (as opposed to commercial rent) is input taxed. Dividends and distributions do not attract GST.
