Tax-deferred income is a key feature of many unlisted property funds and can be a valuable component of an overall investment strategy. For many investors, it represents an opportunity to enhance after-tax returns and better manage the timing of tax liabilities.
The Federal Government’s proposed changes to negative gearing on residential investment properties and Capital Gains Tax (CGT), combined with tax time approaching, offer a timely reminder to reflect on the power of tax-deferred income.
While the concept can seem technical at first, understanding how it works can help investors make more informed decisions about income, tax timing and long-term outcomes.
What is tax-deferred income?
When you invest in an unlisted property fund, you typically receive regular distributions, usually generated from rental income and other earnings from the underlying properties.
A portion of these distributions may include a tax-deferred component. This means that part of the income you receive is not taxed in the year it is paid. Instead, it is applied to reduce the cost base of your investment.
Your cost base is used to calculate any capital gain when you eventually sell or redeem your units. By reducing this cost base over time, tax-deferred income effectively postpones the tax liability until a future point. In simple terms, the tax is deferred.
How does it help?
Deferring tax can create meaningful benefits for investors, particularly when considered in the context of long-term investment strategies and retirement planning.
- Flexibility: Because the tax-deferred portion of a distribution is not taxed immediately, you receive more net income upfront that can be reinvested or supplemented towards lifestyle.
- Lower tax rate: When you eventually sell your investment, the reduced cost base may result in a larger capital gain. Under the proposed CGT changes, the flat 50% discount has been changed to an indexation tax method across all capital gains. The impact of the proposed changes to CGT on commercial property investors will often result in a lower effective tax rate compared to paying tax on income each year.
- Retirement transition: Tax-deferred income can transition into the retirement, or pension, phase without triggering an immediate tax event. Once in pension phase, investment earnings and realised capital gains are generally subject to more generous tax rules.
How do tax-deferred distributions arise?
Tax-deferred distributions occur when a fund’s cash income exceeds its taxable income, usually driven by non-cash deductions like depreciation and amortisation.
Property funds operated by Westbridge are usually structured through trusts, meaning investors are taxed on their share of the income of the trust. While rental income and capital gains flow through to investors in the usual way, tax-deferred distributions are treated beneficially for tax purposes.
What influences the level of tax-deferred income?
The amount of tax-deferred income can vary between funds and from year to year. Key factors include:
- Asset type and age
Newer properties generally have higher depreciation allowances, which can increase the tax-deferred component. - Portfolio activity
If a fund sells assets and realises capital gains, distributions may include more taxable components, reducing the tax-deferred portion for that period. - Fund strategy and structure
Different funds will have varying levels of deductions and income profiles.
Because of these variables, it is important to review tax statements each year to understand the exact breakdown of distributions. Take this as your friendly reminder to check with your advisor about your tax-deferred distributions at tax time.
This information has been prepared by Westbridge Funds Management as a general guide only. 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 Pty Ltd ABN 33 652 852 214 AFSL 533936. Westbridge Asset Management Pty Ltd ABN 48 151 957 676. Westbridge Property Securities Ltd ABN 28 091 623 862. AFS Licence 238386.