What is tax deferred income?

Property trusts have a proven reputation as a reliable source of regular income. Better still, some of that income may be tax deferred. We explain what this means and how tax deferred income can benefit you as an investor.

Much of the appeal of unlisted property funds – like those offered by Westbridge – is the opportunity to earn a regular income.

The bulk of this income comes from rent earned on the fund’s underlying properties. And as rent is usually paid monthly, Westbridge is able to pay distributions monthly for most of our funds, which is a real plus for an investor’s personal cash flow.

Why tax deferred income arises

As an investor in unlisted residential or commercial property funds, you may find that your regular distributions include a ‘tax deferred’ component.

This can arise because the fund has tax deductible costs, such as depreciation and capital works on the buildings themselves. That leads to a situation where the income the fund has available to distribute to investors is different from its taxable income.

It can sound complicated. The main point for investors, however, is that tax deferred income can provide valuable tax savings.

That’s because the tax deferred part of a fund distribution is not assessed as taxable income when it is paid to the investor.

Instead, the tax deferred component is delayed or ‘deferred’ until such time as you sell or redeem the units in a fund. At that point, it is used to reduce the cost value of your investment when capital gains tax (CGT) is calculated.

How does tax deferred income work?

As an example, let’s say John invests $100,000 in an unlisted property fund. We’ll assume his personal marginal tax rate is 32.5%, which means he earns between $45,000 and $120,000 annually.

John receives a fund distribution of $8,000 annually. The fund lets him know that distributions are 40% tax deferred.

The table below shows how the tax deferred income works in John’s favour.

If there were no tax deferred income, John would include the full $8,000 distribution as income in his tax return. This would see tax work out to $2,600 ($8,000 x 32.5%), leaving John with after-tax income of $5,400.

However, because the distributions are 40% tax-deferred, John only includes on $4,800 of the income distribution in his tax return for the relevant income year. The tax payable in this case would be $1,560 ($4,800 less x 32.5%). As a result, John earns after-tax income of $6,440 from his distribution, resulting in an extra $1,040 cash in his pocket each year.

The upshot is that tax deferred income can boost an investor’s cash flow, providing additional cash that can be used to fund other investments to grow wealth over time.

The impact of tax deferred income on capital gains

Remember, the tax deferred component of distributions may reduce the tax paid on annual distributions, but it also reduces the cost base of the investment in the fund.

Let’s revisit John’s example to see how this can play out.

John’s cost base:

Price paid for fund units                               $100,000

Less: The tax deferred amount                        $3,200 ($8,000 x 40%)

Cost base of John’s investment                  $ 96,800 ($100,000 – $3,200)

In this example, the cost base of the units will reduce by the amount of the tax deferred distribution. If John were to sell his units for $105,000, the capital gain on the sale would be $8,200, being the proceeds from sale less the new cost base of the investment.

Moreover, if John holds the units in the fund for more than 12 months, he is entitled to a 50% discount on any capital gain. So, he’ll only pay CGT on $1,600 ($3,200 X 50%) of the tax deferred income component.

To know more about tax deferred income in relation to managed funds, contact us on 08 9321 5566 or submit an online enquiry form below and one of our friendly team will be in touch.

This information has been prepared by Westbridge Funds Management as a general guide only. It does not constitute an offer for sale, or solicitation for the purchase of securities, financial products or other investments. It should not be relied upon to determine or to make decisions about the investment objectives, financial situation or individual needs of any person. Westbridge Funds Management recommends investors seek professional advice before making a decision to invest. Westbridge Funds Management and its related entities do not make any representations or give any warranties that the information contained within is or will remain accurate or complete at all times and they disclaim all liability for harm, loss, costs, or damage which arises in connection with the use or reliance on the information. Manager, Responsible Entity and Product issuer: Westbridge Funds Pty Ltd ABN 33 652 852 214 AFSL 533936. Mair Property Funds Limited ABN 48 151 957 676 t/a Westbridge Asset Management. Mair Property Securities Limited ABN 28 091 623 862. AFS License 238386. Momentum Wealth Projects Pty Ltd ABN 29 090 792 439 t/a Westbridge Urban.

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