Tax Deferred Income: What is it and Why Does it Matter?
For Australian commercial property investors, tax efficiency plays a crucial role in maximising returns. One of the most significant, yet often misunderstood, concepts in this space is tax deferred income. Understanding what it is — and why it matters — can give investors a distinct advantage in building long-term wealth.
What is Tax Deferral?
Put simply, tax deferral refers to the postponement of tax liabilities to a future date. In the context of commercial property investment, it typically applies to income distributions that carry a deferred tax component. Instead of paying tax on the full amount of a distribution when it is received, a portion of it can be deferred — meaning investors won’t pay tax on it until a later event, such as the sale of the asset.
This deferral is commonly achieved through non-cash deductions such as depreciation and capital works allowances. These deductions reduce the taxable income of a property trust or managed investment scheme, often resulting in distributions to investors that are partially or wholly tax-deferred.
Why Does it Matter?
For investors, tax-deferred income can provide several compelling benefits:
- Improved Cash Flow
Because part of the distribution is not taxed immediately, investors retain more of their income in the short term. This can significantly improve cash flow, enabling reinvestment or debt reduction — both of which contribute to greater overall returns. - Compound Growth Opportunity
Reinvesting tax-deferred income can accelerate portfolio growth. Instead of paying tax upfront, that capital remains in play, compounding over time. The result is a more efficient use of capital that can lead to higher long-term performance. - Potential Capital Gains Treatment
When tax is eventually paid — typically upon the sale of an asset or disposal of units — it may be treated as a capital gain, which in Australia can be subject to a 50% discount if the asset is held for more than 12 months by individuals or trusts. This often results in a lower effective tax rate compared to income tax. - Effective Tax Planning Tool
For high-net-worth individuals and self-managed super funds (SMSFs), tax deferral allows for strategic timing of tax liabilities. This can be particularly advantageous when planning retirement, managing marginal tax rates, or coordinating with other income sources.
Click the link below to watch our episode of the Quantacast where BDO partner Chris Ball discusses the benefits of tax deferred income.