The 3 worst ways to reduce your tax
Tax. It’s a necessary evil but let’s face it, nobody likes paying tax.
A big part of any financial plan is understanding our tax obligations and structuring our finances in a way that achieves good tax outcomes.
Whilst the most important thing in a plan is not how much tax you pay, it is an important part of the process.
In my years as a financial adviser, I’ve seen lots of ways people have tried to reduce their tax with some strategies much better than others. In this article, I’ll outline the 3 worst ways I see people try to reduce their tax.
Number 1: Losing money on investments deliberately
I see this far more commonly than you would expect.
The most common example of this is where people charge rent on their investment property at below market value.
I’ve heard a number of reasons justifying this including:
“I want to reward my good tenants”
“It’s helpful for budgeting to get a bigger tax return”
“I don’t want my property to be positively geared so I reduced the rent”
Needless to say losing money on purpose is the quickest path to financial failure.
If your property is negatively geared, you’re only getting a portion of the loss back.
If your property is positively geared, whilst you are paying tax, it means you are making money which is a good thing.
Number 2: Buying things you don’t need (or leasing expensive cars)
This is another common mistake I see people making, especially business owners.
As a general rule, the discount you receive when something is tax deductible is your marginal tax rate. For example, if you buy something for $500 and your tax rate is 39%, then you get a discount of $195.
This is a great discount if you needed to buy that item for your job or business, but it’s still spending money if you didn’t.
Another common example here is leasing an expensive car. Whilst your tax may be slightly reduced, you’re still paying for an expensive car.
Number 3: Buying property solely for ‘the tax benefits’
Investing in property can be a great way of building wealth, but you shouldn’t be doing it just to save on tax.
When you have an investment property, you can usually claim depreciation on the building and various items affixed to the property. Whilst it’s great to get a tax deduction each year, these items are in fact depreciating and will one day need replacing or fixing.
Whilst getting an upfront tax deduction can be useful, it’s important to consider this in the context of your greater plan.
I would also not suggest buying new property solely for the reason that it maximises your depreciation. This is commonly a tactic real estate agents use to encourage you to buy property which pays them a higher commission.
What about you? Have you seen any ineffective (or even dodgy) ways people have tried to reduce their tax?