Buy to let mansion- tax deductions

[Matt_Black]

Before I consult an accountant on this, I'd like to pick your brains.

I'm exploring buy to let apartment as an investment option and would like to better understand the concept of using the property to reduce income tax.
I understand that this is mostly beneficially to those in the higher income tax brackets. Has the loophole been closed or can be leveraged still? This article indicates that the government was to close it in 2021.
https://housekey.jp/reduce-your-taxes-j ... reciation/

[Wales4rugbyWC23]

Before I consult an accountant on this, I'd like to pick your brains.

I'm exploring buy to let apartment as an investment option and would like to better understand the concept of using the property to reduce income tax.
I understand that this is mostly beneficially to those in the higher income tax brackets. Has the loophole been closed or can be leveraged still? This article indicates that the government was to close it in 2021.
https://housekey.jp/reduce-your-taxes-j ... reciation/

Depreciation for foreign held properties, yes has been closed. Just squeaked in, it really is sweet.

I think for Japanese properties it still exists, because they really do depreciate in price.

[Matt_Black]

Before I consult an accountant on this, I'd like to pick your brains.

I'm exploring buy to let apartment as an investment option and would like to better understand the concept of using the property to reduce income tax.
I understand that this is mostly beneficially to those in the higher income tax brackets. Has the loophole been closed or can be leveraged still? This article indicates that the government was to close it in 2021.
https://housekey.jp/reduce-your-taxes-j ... reciation/

Depreciation for foreign held properties, yes has been closed. Just squeaked in, it really is sweet.

I think for Japanese properties it still exists, because they really do depreciate in price.

Thanks for the input. I came across the following info which makes me more interested in Japanese real estate.

https://housekey.jp/reduce-your-taxes-j ... reciation/

"The Japanese government assumes that, due to earthquakes, normal wear and tear, etc., your concrete building will last for 47 years, your brick building, 38 years, and your wooden building, 22 years, then be demolished (or so they think). The government allows you to make a deduction every year for “depreciation”. However, in reality, you could be the owner of a pristine 47-year-old building; it might stand for another 47 years! The government doesn’t care. They’ll just look at their table on a piece of paper and declare “The building decreased in value by 1/47th this year”.

Imagine buying a concrete building worth ¥20,000,000. It’s used and has 20 years’ depreciation left on it, according to the government, because it’s already 27 years old. For the next 20 years, it will depreciate by ¥1,000,000. Now imagine that your tenants are paying ¥1,000,000 per year in rent. The two numbers will completely cancel each other out. You will pay nothing at all in income tax for that building."

"Once fully depreciated, if the building is sold to a new owner, the depreciation starts again, on an accelerated schedule. Suppose you buy an old wooden house worth ¥10,000,000 (not including the value of the land [no depreciation]), already, say, 30 years old (fully depreciated). However, when you buy it, a new, four-year depreciation schedule starts. For the next four years, you can write off ¥2,500,000 from your income tax for that building. This affects not only rental income, but income from your day job, too; if in the 45% tax bracket, that would be a savings of ¥1,125,000 yen on your tax bill for the next four years."

[Tkydon]

Yes, Only for Rental Properties and now Only for Japan Properties (no longer available on overseas properties), not for your residence, you divide the purchase price between the cost of the land, which cannot be depreciated, and the cost of the structure, which can be depreciated across the Accounting Useful Life of the Structure, as above.

If you buy the property from a company and pay Consumption Tax, then you can calculate the cost of the structure, which is subject to consumption tax and can be depreciated. The land portion is not and cannot be...

The Depreciation Expense is obviously very large, and turns the net profit of the rental property into a net loss, which you can then take against your aggregate Taxable Income, reducing your taxable income, and therefore your income tax.

You have to remember that, IF you take the Depreciation Expense, it reduces the Tax Basis of your property; You have to deduct the depreciation from the Purchase Price every year. You will then end up paying Capital Gains Tax on any gain over that lower amount of the purchase price minus the total depreciated claimed at the Long-Term Capital Gains Tax Rate of 20.315% (15% National, 0.315% Reconstruction/Defence, and 5% Residents' Taxes), if there is any.
You are only deferring the Taxes...
Therefore, if your taxable income is greater than about Y6.6M, then your current Marginal Aggregate Tax Rate (National, Reconstruction/Defence, and 10% Residents' Taxes) is greater than the 20.315% Capital Gains Tax Rates above, and therefore you can arbitrage the current Tax Saving against the future capital Gains Taxes in the future.
You should consider though that the amount of the tax saving is probably going to be required over the life of the property for repairs / maintenance / improvement, but you can add that reinvestment back (and depreciate that over future years) to increase the tax basis and decrease the ultimate Capital Gains Taxes...

[Tkydon]

I promised a 101 doc, so here it is. I'm sure others will offer opinions, suggestions, or corrections... Gratefully received...

Income Tax Reduction Through Property Ownership - How does it work?

This is Not a Tax Elimination, but a Tax Arbitrage Play. See below...

Let me see if I can remember and capture all the moving parts... You have to go through the entire process...

The Overseas Property Depreciation loophole (Using overseas Property Depreciation to offset Income Taxes on Salary and Other Income) was closed in 2021 for Individual Investors.
The scenario I describe below is for Japanese Properties.
Apparently, corporates can still use it... (Need confirmation)


Firstly, For investment condominiums in Japan, as a retail investor...

1. You buy a New or Fairly New Investment Condominium / Manshon (assuming major city, and not Akiya)
The Price consists of the price of some portion of the Land, the price of the Structure and Fixtures & Fittings, and as the property is purchased from a company or agent, Consumption Tax on the price of the Structure and Fixtures & Fittings, and Property Registration Tax.
The Price is the Tax Basis for calculation of Capital Gains on future sale.

The price will be set according to the projected rental income for the property with a Rimarari - Gross Rental Yield of something around 3%-4%, depending on the area, etc.. This may have gone up with rising interest rates...
If a Condo was expected to rent for say Y100,000 per month, or Y1.2M per year, then the Purchase Price might be in the region of:
Y1.2M / 4% = Y30M
to
Y1.2M / 3% = Y40M

You will notice, for a higher Rimawari - Yield Return - the purchase price is lower, and vice versa.
As Interest Rates rise, the Rimawari - Yield Return - to the purchaser must rise, and property price must fall.
For higher Rental Income, the property price will rise.

You (maybe) pay a down payment and take a Mortgage for the rest of the Purchase Price. Say 20%-80%, or other split. Say Y8M and a loan of Y32M
As these condos are aimed at retail investors, they are willing to lend higher loan to price to qualified borrowers, but the retail investor pays for that in lower Rimawari - Yield Return, and a higher loan interest rate.

The Mortgage Payment includes Principle Repayment and Interest on the Remaining Balance.
For an Owner Occupier with income below a certain threshold, the Owner Occupier can get Mortgage Tax relief for a certain number of years (currently 8 years) equal to 1% of the outstanding loan balance at the end of the tax year (equivalent to about 1% interest rate rebate).
The interest rate for a Rental Property Loan will be higher than a Primary Residence Owner Occupier Loan, and there is no Mortgage Tax Relief on Rental Property. Instead, you get to expense Depreciation (See later).
The Interest portion counts as an Expense, and is deductable against the rental income. The Principle Repayment portion does not.

2. You rent out the property
If you use a Management Company to manage the rental of the property, they will take a Management Fee, usually 10%-15% of the Rental Income, which counts as an Expense. They will keep the accounts and provide the year-end figures for your Tax Return - Kakutei Shinkoku.
The tenant pays rent, which (maybe... in the early years...) will be close to the Total Mortgage Payment. +/-
The tenant pays the property management fee to the Property Management Company, for shared services; staff, cleaning, landscaping, garbage collection, public area lighting, repairs, etc..
You pay the annual Property Fixed Asset Tax - Kotei Shisan Zei to the Local Authority.

3. You, or the Management Company, or your Accountant, draws up accounts for the Property;
Rental Income on one side
Interest, Management Fees, and other Expenses and Taxes on the other side.

The difference (profit) would be subject to Income Tax in Japan, even if the landlord is overseas...
The Post-Tax remainder will be used to pay the Loan Principle Repayment - Using the Free Cashflow to pay down debt...
After everything, it may leave you with a small amount of Positive Net Cashflow, or it may come up short, and you may have to put additional money out of your pocket to meet the shortfall; Negative Net Cashflow, at least in the first couple of years until rents have risen a bit.

4. You then take Depreciation as an Expense.
Under Japanese Accounting Principles, the Structure and Fixtures and Fittings, but not the Land, are depreciable.
A Steel Reinforced Concrete Structure is depreciable over a Useful Life of 47 Years. You can take 1/47th of the Purchase Price of the Structure every year as an Expense.
Fixtures & Fittings are depreciable over a Useful Life of 15 Years. You can take 1/15th of the Purchase Price assigned to Fixtures & Fittings every year as an Expense. This also applies to renovations and interior decor, etc..
If it is an older building, you can take Accelerated Depreciation over a much shorter period of time to create a greater tax deduction.
The sum of these Expenses will be much larger than the profit from the Rent, and will produce a Accounting Loss.
This Loss can then be carried over from the Accounts of the Property to your other Japan Income Tax as a Loss Deduction, thereby reducing your Total Taxable Income, producing a Tax Saving at your Marginal and Reconstruction/Self Defense Tax Rates and Residents' Taxes at 10%.
So, at the end of each year you should receive a (significant) Tax Rebate from Withheld Income Tax for the Accounting Loss incurred, if you have been paying tax through withholding.

5. Depreciation Expenses reduce the Tax Basis of the Property
As you take the Depreciation Expense every year to reduce your taxes, The Tax Basis is reduced by the value of the Depreciation expense claimed, so the New Tax Basis is the Old Tax Basis minus the Total Depreciation Expense claime , for calculation of Capital Gains on sale.

Any Maintenance, Repairs, Improvements or Investment can be added to the Tax Basis, and can be expensed or depreciated over the applicable Accounting Useful Life, again reducing the Tax Basis.

The Primary Objective here is NOT the tax saving. That is a Tax Arbitrage play.
Just as with an iDECO, this strategy enables you to (re-)invest money Pre-Tax, so higher input at a higher tax rate tax saving, only to pay taxes at sale at the lower Capital Gains Tax Rate. See below.
Over the years, you may be able to increase the rent, or refinance to reduce the interest rate, so that it becomes (more) Net Cashflow Positive.

6. As you pay down the Mortgage, your remaining balance decreases and your equity in the property increases.
If you ever decide to sell...
The structure and fixtures & fittings have depreciated in value, but the land may have increased in value, balancing that out, depending on where the property is located...

Assuming you own the property for more than 5 years, so that it becomes liable for Long-Term Capital Gains Tax on sale (as opposed to Short-Term Capital Gains Tax on property owned for less than 5 years), then the Taxable Capital Gain will be the Selling Price minus the Tax Basis, minus transaction costs, minus the Capital Gain Deduction of Y500,000.
Any Taxable Capital Gain will be taxed at 20.315% (15% National, 0.315% Reconstruction and Self Defence, and 5% Residents' Taxes).
If you were to move back into the property for some time before selling, instead of the Capital Gain Deduction of Y500,000, you could potentially claim a Capital Gain Deduction of (some portion of) Y30,000,000 as your Primary Residence.

The rent might have increased over the time you owned the property, and another investor might offer a price to produce a Rimawari or Rental Yield of say 5% as it is now an older property, in need of some maintenance, say:
Y110,000 per month or Y1,320,000 per year rental Income / 5% Yield = Y26.5M

Therefore, you would pay 20.315% tax on any gain, including the Depreciation you have claimed as an Expense over the years. The Depreciation may have brought the Tax Basis down below this value.

Therefore, this is Not a Tax Elimination, but a Tax Arbitrage Play. If the tax saved through the years at your Marginal National Tax Rate + 0.21% of that for Reconstruction / Self Defense, and 10% Residents' Taxes is greater than 20.315%, you have saved tax, but you also had the opportunity to invest and grow that money pre-tax.
e.g. If your Marginal Tax Rate is 33% National + 0.693% Reconstruction / Self Defense + 10% Residents' Taxes = Total 43.693%, you would save tax at that rate on your employment income, and later pay the Capital Gains Taxes on that money at just 20.315%.


If the Selling Price is lower than the Tax Basis plus the Capital Gains Deduction of Y500,000, you pay no Capital Gains Taxes on the sale.
You pay off the remainder of your Loan, and walk away with the amount of your Equity in the Property minus any Capital Gains Taxes (possibly Tax Free...).

7. Your actual Return on your Investment will be:
( ( ( (Your Final Payout - any further investment - Down Payment) / (Down Payment + any further investment) )^(1/n years)) - 1) x 100 % per annum
Maybe about 7% per year over 10 years...


For an old timber structure in Japan... Notice the subtle differences...

1. You buy an old property. The Price consists of the price of the Land, the price you pay for the Structure and Fixtures and Fittings, and if the property is purchased from a company or agent, Consumption Tax on the price of the Structure and Fixtures and Fittings, and Property Registration Tax. The Price is the Tax Basis for calculation of Capital Gains on the future sale.

Again, the property price might reasonably be calculated based on projected rental income, but an older property might command a higher Rimawari - Rental Yield, of somewhere in the order of 10% perhaps...

If you can get a mortgage on the property, you pay a down payment and take a Mortgage for the rest of the Purchase Price. Say 20%-80%, or other split.
The Mortgage Payment includes Principle Repayment and Interest on the Remaining Balance.
The interest rate for a Rental Property Loan will be higher than a Primary Residence Loan, and there is no Mortgage Tax Relief on a Rental Property Loan. Instead, you can take Depreciation as an expense (See later).
The Interest portion counts as an Expense. The Principle Repayment portion does not.

2. You rent out the property, maybe as a rental or maybe on AirB&B, vacation rental, or other...
If the property is vacant, you can of course use it for your own use.
If you use a Management Company to manage the rental of the property, they will take a Management Fee, perhaps 10% of the rental income, which counts as an Expense.
The rental income will hopefully cover the Total Mortgage Payment, maybe with some positive cashflow left over. Or maybe not, and you may have to fork out additional money every month to cover the shortfall...
You have to pay the annual property Fixed Asset Tax - Kotei Shisan Zei.

3. You draw up accounts for the Property
Rental Income on one side
Interest, Management, and other Expenses on the other side

The difference (if profit) is subject to Tax
The Post-Tax remainder will be used to pay the Loan Principle Repayment. Using Free Cashflow to repay debt.
It may leave you with a small amount of net Positive Cashflow, or it may come up short, and you may have to put additional money to meet the shortfall, net Negative Cashflow.

4. You then take Depreciation as an Expense.
Under Japanese Accounting Principles, the Structure and Fixtures & Fittings, but not the Land, are depreciable.
A Timber Framed Structure is depreciable from new over a Useful Life of 22 Years. You can take 1/22nd of the Purchase Price of the Structure every year as an Expense.
BUT...
However, in this case the property is older than 22 years, and effectively the structure has zero value for accounting purposes.
However, you have paid more than the price of the land, and so the amount paid for the property over the price of the land is deemed to be the price paid for the structure, and you can use Accelerated Depreciation and can be depreciated over 4 years; 1/4 of the price of the structure can be taken as an Expense every year for 4 years.

The sum of these Expenses will be larger than the profit from the Rent, and will produce a Accounting Loss for those 4 years...
This Loss can then be carried over from the Accounts of the Property to your Income Tax as a Loss Deduction, thereby reducing your Total Taxable Income, producing a Tax Saving at your Marginal National and Reconstruction / Self Defense Tax Rate and Residents' Taxes at 10%.

5. Depreciation Expense reduces the Tax Basis of the Property
As you take the Depreciation Expense every year to reduce your taxes, The Tax Basis is reduced by the value of the Depreciation, so the New Tax Basis is the Old Tax Basis minus Depreciation for calculation of Capital Gains on sale. After 4 years, the Tax Basis is the price paid for the Land, and you have exhausted the Depreciation deduction.

Any maintenance, Improvements or Investment can be added to the Tax Basis, and can be taken as an expense or depreciated over the applicable Accounting Useful Life, again reducing the Tax Basis. There are a also certain tax incentives for property improvement work.

The difference between this and the previous example of a New or Reasonably New Condo is that the Depreciation Expense runs out after 4 years.
For those 4 years, you may have been able to significantly reduce your Income Tax by the Depreciation Loss, but from the 5th year onwards, you will not have any Depreciation Loss, and the mortgage payment will still have to be paid, leaving you with a net positive or negative cashflow...
So, at the end of each year for those 4 years, you will receive a (significant) Tax Rebate from Withheld Income Tax for the Accounting Loss incurred, if you were having tax withheld through the year. From Year 5, you will only be able to expense any actual loss from the property operation.

6. As you pay down the Mortgage, your remaining balance decreases and your equity in the property increases.
Assuming you own the property for over 5 years, so that it becomes liable for Long-Term Capital Gains Tax on sale (as opposed to Short-Term Capital Gains Tax), then the Taxable Capital Gain will be the Selling Price minus the Tax Basis, minus transaction costs, minus the Capital Gain Deduction of Y500,000.
Any Taxable Capital Gain will be taxed at 20.315% (15% National, 0.315% Reconstruction and Self Defense, and 5% Residents' Taxes).

Therefore, you end up paying 20.315% tax on all the Depreciation you have claimed as an Expense over the years.
Therefore, this is again a Tax Arbitrage Play. If the tax saved over the 4 years at your Marginal National and Reconstruction and Self Defense Tax Rate, and 10% Residents' Taxes is greater than 20.315%, you have saved tax...
If the Selling Price is lower than the Tax Basis plus the Capital Gains Deduction of Y500,000, you pay no Capital Gains Taxes on the sale.
You pay off the remainder of your Loan, and walk away with the amount of your Equity minus any Capital Gains Taxes (possibly Tax Free...).

7. Your actual Return on your Investment will be
( ( ( (Your Final Equity - Down Payment - Other Investments ) / (Down Payment + Other Investments ))^(1/n years)) - 1) x 100 % per annum

If the property is really old, you may not be able to sell it for more than the value of the land, and furthermore, you may have to clear the land before sale, so you may have to incur the price of demolition of the structure to provide the vacant lot, which would impact your potential profit.


If you purchase a whole building in Japan:
The Rimawari is likely higher; in the region of 10%
With a Higher Rimawari, you stand a much better chance of being significantly Cashflow Positive every Month, but you should remember that that Cashflow may be needed for building maintenance, repairs, room decoration, refurbishment, etc. that are all on you.
The Risk is spread across multiple units, so hopefully they are not all vacant at once.
Depreciation still applies.
You can improve the value of the building as a whole by carrying out property improvements in order to raise the rental income, and sell the property at the same 10% Rimawari on a higher Income stream, so at a higher price.
You may also be able to refinance the loans to lower interest rates over time, so that you can pay down the loan...


Your profit is NOT on the net monthly cashflow. Your Profit is on the difference between the Down Payment; the amount you actually put into the property, and the Money you walk away with after paying all the expenses, pay off the loan and pay any Capital Gains Taxes... and the Tax Arbitrage between the savings at your Marginal Tax Rates during the time you own the property and the Capital Gains Tax, if any, when you sell...

Finally, if you put a down payment, the rental income pays the mortgage, both the interest and the principle repayment, you may have to put a little bit for repairs, upgrades etc. on tenant changes, but over the years the loan would be paid down depending on the interest rate, and you may have taken some tax deductions over the years, and the difference between the Loan Outstanding Balance and the Selling Price will be the value of your equity in the property. Even after Capital Gains Taxes, you should walk away with significantly more than your down payment you put in, and you can then calculate the Gross Gain over the down payment, and from that calculate the annual gain on your down payment, even if there was no significant gain in the value of the property over the period. Even though the Rimawari Cash-On-Cash Return values in the examples above may be 3%, 4%, or 10%, the return you achieve on your down payment investment should be much higher than that.

You, or your accountant, would have to run the numbers on your actual circumstances, taking into account all the factors stated above.

I'm sure someone will find errors. Please feel free to offer opinions, suggestions, or corrections...

[Beaglehound]

I do appreciate your effort Tkydon, but my opinion is that this thing called life is way too short for the convoluted systems we have created.

[eyeswideshut]

If you were to move back into the property before selling, instead of the Capital Gain Deduction of Y500,000, you could potentially claim a Capital Gain Deduction of Y30,000,000 as your Primary Residence.

Is this true? If so it is quite a tax dodge. Thanks for the detailed write-up. Before they closed the loophole I did this for overseas properties and, assuming the logic is the same, what you state seems generally correct to me.

[eyeswideshut]

Depreciation for foreign held properties, yes has been closed. Just squeaked in, it really is sweet.

Are you still claiming the depreciation? They did not allow people to grandfather already purchased properties when they changed the law- at least that is what my accountant told me - so you cannot not claim depreciation of any overseas units post FY21 (whether already purchased or newly purchased). If I am wrong definitely let me know as I will have left a lot of tax savings on the table over the past 2 years.

[Wales4rugbyWC23]

Depreciation for foreign held properties, yes has been closed. Just squeaked in, it really is sweet.

Are you still claiming the depreciation? They did not allow people to grandfather already purchased properties when they changed the law- at least that is what my accountant told me - so you cannot not claim depreciation of any overseas units post FY21 (whether already purchased or newly purchased). If I am wrong definitely let me know as I will have left a lot of tax savings on the table over the past 2 years.

I bought the flat in December 2020 which I think just qualifies me. Also, all property taxes are deductible. Stamp duty for buy to lets in the UK has become quite expensive over the last few years.

[eyeswideshut]

I bought the flat in December 2020 which I think just qualifies me. Also, all property taxes are deductible. Stamp duty for buy to lets in the UK has become quite expensive over the last few years.

Definitely correct on the property taxes and basically all other fees and taxes related to the purchase, maintenance and management of the property. Those can all be used to create a loss that can be applied to your total income. But my understanding is that you cannot use depreciation expense on overseas properties from 2021 regardless of when they were purchased. In other words, 2020 was the last year this loophole could be used. So if you have been deducting depreciation for your flat in your 2022 and 2023 tax filings you may want to consult a professional just to confirm that this was done correctly.

I bought a place overseas in 2019 (wood-frame, 20+ years, accelerated depreciation over 4 years) and could only use the depreciation amount for the remaining months of 2019 and the full 12 months of 2020. I asked my accountant if there was any grandfathering exception and he said no. It was a hard closure on the loophole.