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How Do You Evaluate Government Tax Incentives?

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  • How Do You Evaluate Government Tax Incentives?

    Hi Colm,

    Do you provide any information on how to evaluate government tax incentives as a component of making property developments more profitable ventures?

    We are evaluating serveral historical commercial properties that are eligible for these incentives and would like to know how to factor them into our evaluation criteria. Any hints?

    Nick P

    Hello Nick,

    Interesting question ... thank you.

    It would have helped me more if you told me how the Gov's Tax Benefit is given to you and then I could be more specific ... also what country you live in would help.

    Anyway I'll do the best I can with my two fingered typiNG style.

    This brings up a small point ... on my web page I invite questions, so that I can help you. I have written on the side of the entry box ... More words rather than less (in your question) will help me - to help you.

    OK, let's get into it.

    I would imagine that any assessment would be determined by the way in which the Government Tax Incentive is given to the Applicant.

    I will assume that you will not be paid cash up front or during the development - Governments like to keep their hands on money, eh?

    I think the tax incentive will be applied in a form like they handle "Depreciation" on a building.

    For example in Australia investors are able to depreciate their investment buildings at the rate of 2.5% over 40 years
    (40 x 2.5% = 100% write off).

    We can also depreciate building equipment at various rates over the life, such as airconditioning, building lifts etc.

    The tax act evaluates the life of such equipment and allows investors to deduct each year a certain predetermined percentage over the life the building is owned for each item - so the Tax Depreciation Schedule is a very interesting and profitable read.

    As most of us developers are "action people" there will be a natural reluctance to read this stuff. Sorry guys, just do it, you'll be glad you did.

    Anyway, back to the question.

    I suggest that this may be the way your incentive will be determined.

    Remember, Government, in doing it this way, is not giving you money, rather they are only forgoing future cash that they would not get, unless you decided to invest you time and money on an old building.

    So I think it will come in the form of a future benefit. If this is so, then you will complete the redevelopment in the normal way.

    When completed, you will decide to retain the property as a long term investment or to sell it to someone else as a long them investment.

    The renovated building will be occupied by a tenant or a number of tenants. They will pay a Gross Rent and from that rent the investor will deduct his costs of running the building; rates, taxes, electricity etc.

    This will result in a Net Rental Income. This being the amount that goes into the pocket, OK?

    Well, I should say the Net Rental Income goes into the pocket AFTER YOU PAY TAX ON IT.

    Can you see where the Gov Tax benefit comes in?

    The tax benefit being offered to you will result in you paying less tax and so get more net income in your pocket after tax.

    Just to ram home the point.

    If, after deducting all the normal running costs your taxation regime allows, you have say, a Net Rental Income of $100,000.

    Under normal circumstances, you would pay tax on the $100,000. However if your special Government Tax Incentive amounts to $20,000, then you will only pay tax on $80.000, so improving the number of dollars in the investors pocket and therefore the return on investment.

    Hope this answers your question.

    A short "real" story as an example. I like stories, because they help you remember things better.

    I have always wondered why property, when being offered for sale, is always quoted as a Gross Return on investment. You've seen them advertised, "Buy This Property for 7% Return."

    You see your investment earns a Net Return. The Net Return is arrived at after you take into account all of the tax deductions.

    The Gross is what the tenant pays, but you, the investor have running expenses don't you?

    In fact I know why the Gross Return is quoted ... the industry feel that as each individual's tax rate is different, so they think it is better to quote Gross Return.

    I still don't accept that ... because if you decide to use the top rate of tax for everyone, you are still giving people a more accurate picture of "How Good" property investment returns are.

    A Real Example.

    In 1981 I developed a 13 level commercial strata title office building for sale to individual professionals who worked in the CBD (Central Business District).

    Tradition and the market told me to advertise each office suite at a sale price of 8% return.

    Anyone who has read my stuff knows my credo

    ... the hardest work we do is "think" ...
    after that it's all "process" ...

    So I decided to get the tax code and asked my Quantity Surveyor to prepare a final cost break down of all the building elements on a strata suite basis that the tax code allow to be deducted.

    The result, after just taking into account the depreciation only, was that I was able to advertise a Return of 17% --- not a gross of 8%.

    How do you think the building SOLD - The word Rocket comes to mind.

    I was able to develop two other office buildings on the same basis, before the industry caught on.

    Oh yes, there is now a new branch of the Quantity Surveying in Australia, that does nothing else except create Depreciation Schedules for investors.

    Funny, they didn't exist before 1981.

    All the best,

    Colm Dillon