In part two of our guide to property investing, we pick up where we left off last month and find out what happens after you've found a property.

If you haven't read the first article in this series you can read it by clicking this link

Buying a property can be one of the most important financial decisions you'll ever make. Even more so if it's an investment property because, unlike a place you buy to live in, purchasing an investment property is a business decision. 

In last month's article, part one of our beginner's guide looked at: the importance of getting good advice; working out a strategy; arranging finance; doing research; knowing what to buy; and liaising with real estate agents.

This time around we'll look at: sealing the deal; the legal aspect of a purchase; common mistakes; costs associated with buying; property management; and taxation. We'll also provide some useful tips and explain why property investments are such a popular vehicle for wealth creation.

Ready to buy
Okay, so you've found a property that's ripe for the picking. You've done your homework on the area and you've come to the conclusion that this is 'the one'. Now it's crunch time!

Presuming the property you want to buy is being sold through an agent or directly with the seller (private treaty), this is the point you would begin negotiating a sale. You should always try to negotiate, rather than accept the price.

If, however, the property is being sold at auction, you will need to consider a number of things, such as whether you want to put in an offer prior to auction, what your limit is if you intend to bid, and whether you can meet the terms and conditions of the auction (for example, the seller may require a 10 per cent deposit on the fall of the hammer and a 30-day settlement).

Remember, if you are the successful bidder at auction, the sale is unconditional. There is no cooling-off period and you don't have the luxury of contract conditions (eg. subject to finance approval). With that in mind, it might pay to attend a few auctions beforehand so you can see what happens.

Other methods of sale include expressions of interest and sale by tender.

Before endeavouring to seal the deal, try to ascertain how long the property has been for sale, why the vendor is selling, what offers they've had on the property, what will be included in the sale and how flexible the seller is with contract conditions.

This information, along with research on what similar properties in the area have sold for, will put you in a strong position to negotiate. Even if this is your first time, knowing your stuff will give you the edge you need.

The Queensland Office of Fair Trading's consumer real estate guide, Real Estate Realities, gives the following tips:
 * be wary of accepting advice from professional experts closely associated with the seller;
* seek independent legal advice and an independent valuation before you sign the contract; and
* check the sales contract is accurate and you agree with its contents including conditions that give you adequate avenues to cancel. If you are unsure, check with your solicitor before you sign the contract.

Beware the hidden costs
New property investors don't always realise that the final bill for their acquisition will be for more than just the purchase price - in fact quite a lot more! The different fees that surface when acquiring a property can come as a rude shock, which is why it pays to know what you'll be up for beforehand. 

When you purchase a property you are required to pay stamp duty. The amount of stamp duty varies from State to State, so this is something you'll need to check with the Office of State Revenue. Alternatively, the conveyancer or solicitor handling your transaction will let you know how much you have to pay.

You also have to pay stamp duty on the amount you are borrowing to buy the property. You can obtain this figure from your lending institution.

But there's more! In every State (except the Northern Territory), there's an annual charge applied by the Government to the total unimproved value of land owned in that State called land tax. Again, this tax rate varies from State to State but tends to apply to most investment properties. Your principal place of residence is exempt, subject to certain criteria being met. The details of the land tax scale that applies in your State can be obtained from the Office of State Revenue.

Other costs associated with buying can (but don't always) include mortgage insurance, building and pest inspections, conveyancing and valuation reports. Then, of course, there are the ongoing costs once the property becomes yours, such as property management fees, maintenance and repairs, council rates and insurance.

Building and pest inspections
When making an offer on a property, you should consider adding a clause to the contract making the sale subject to satisfactory building and pest reports. This allows you to enlist the services of building and pest inspectors to assess the condition of the property and inform you of any structural defects or termite damage.
Depending on what the inspectors find, you may be able to use their reports to negotiate contract conditions as well as the price.
Although these reports generally cost a few hundred dollars, they can potentially save you thousands on unforeseen repairs.

Legal matters
You will need to enlist the services of a conveyancer or solicitor to manage the conveyance of the property. Make sure they are appropriately qualified to deal with property transactions because their knowledge and expertise will fill in the gaps of your own inexperience.

If you haven't already done so, you should provide your conveyancer or solicitor with a copy of the contract and associated forms. Not only will they make sure your interests are protected, they will also proceed with the necessary searches of the property on your behalf, the cost of which is usually factored into your total bill.

You can also ask them to prepare an estimate of the costs required for settlement so you have an idea of how much money you will need all up. You are normally required to insure the property as soon as you have signed the contract of sale - not after settlement. Your conveyancer or solicitor can explain more about this to you if you are unsure.

It is the job of your legal professional to manage any issues that may arise between signing the contract and settlement date and to ensure, in conjunction with your lender, that settlement proceeds smoothly.

Property management
Congratulations! Assuming the sale has settled and you have been given the keys to your new property, you are now officially a landlord.

But the decisions aren't over just yet. You now have to decide whether you want to be "hands-on" and manage your investment property yourself or hand over the reins to a qualified property manager.

The benefit of using professional property management is that it frees you from dealing with tenant issues. Furthermore, a property manager is required to keep abreast of changes to the Residential Tenancies Act and is in a position to run checks on potential tenants.

For a percentage of the gross income you earn from your tenants, a property manager will look after the responsibilities of screening potential tenants, handling documentation, and overseeing maintenance and repairs.

Often property agreements last for long periods of time, so make sure you know what you're agreeing to and the services you will receive under the appointment.

If, on the other hand, you choose to do it yourself, you will need to familiarise yourself with the relevant laws and procedures. You can contact your local residential tenancies authority for further information.

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Common pitfalls
Real Estate Institute of Australia president Ian Wells believes making an ill-informed decision to acquire an investment property is the most common mistake new investors make. He says this includes not carrying out sufficient research, not using professionals who have knowledge of investment properties and not fully understanding the ramifications of property ownership.

"If it's residential property, they should have a good understanding of the Residential Tenancy Act in the various States," he says.

"They should be fully aware of the responsibilities of a landlord and a property owner, particularly in regard to their outgoings which are rates, land tax, insurance, maintenance, management, vacancies and things of that nature so that they can truly determine a net return on their property."

Jack Henderson, manager of Metropole Buyers Agency, shares Wells' sentiments, saying novice investors make the mistake of underestimating the acquisition and running costs of an investment property.

"They commit themselves a little bit too high and then are very concerned if it's vacant for a week or can't cash flow minor repairs or refurbishments.

"It also is our habit as beginner property investors, unless we are informed and helped, to buy as close as possible to where we live because we like to live there. That can be a very dangerous trap because where we live may not be such a good investment area with good growth potential and strong rental income," he says.

Stuart Wemyss, chartered accountant and director of mortgage broking firm ProSolution, says often times novice investors don't look far enough ahead.

"Many problems arise for investors when they don't consider how their loan product or structure may affect them in the future," he says. "They don't consider the effects or cost of changing the loan in the future because they are in the mindset of: 'I'll own this property for the next 10 years.' They might sell it because it turns out to be a dud. They might renovate, increase the loan to access equity, etc."

Taking loan advice from inexperienced people is another common faux pas.
"Poor product selection or loan structure often arises out of following advice from people that don't know about property investing and/or aren't investors themselves," says Wemyss. "A good example is people taking advice from inexperienced bank staff. When setting up your loan structure and choosing a lender and product, speak with a knowledgeable professional or other investors."

Wemyss says another common slip-up is when new investors fail to arrange a pre-approval on their finance.

"There is no excuse. All investors should seek a pre-approval before every purchase. This avoids delays and complications," he explains.

A lot of the time when contracts collapse, it is for reasons to do with finance which is why having an inadequate finance clause, or having no finance clause at all, can be a fatal error.

"In most States you can submit offers and sign contracts of sale with 'subject to finance' clauses," says Wemyss. "This allows you to organise finance within a specific period of time. If you cannot organise finance then you can cancel the contract and recover your deposit.

"If possible, always purchase 'subject to finance' and give yourself approximately 14 days from contract date to arrange unconditional finance approval.

"You may not be able to do this in NSW because it is uncommon to include 'subject to' clauses. However you can provide a lender with a draft contract signed by you (the purchaser) and most lenders will then approve finance unconditionally after the valuation has been completed. You can then exchange contracts once this has been approved," he says.

Taxation
Australian Taxation Office marketing and education assistant commissioner, Kathy Dennis-Carter, says recent audits have highlighted poor record-keeping as one of the most frequent blunders made by property investors.

"People don't keep complete and keep accurate records," she says. "That's particularly the case when their circumstances change. For example, where they convert what was once their main residence into a rental property and they don't have the records for the time when their property was their main residence."

Example:
A taxpayer purchased a property in December 1992. His family immediately moved into the property. In March 1993, they decided to renovate to add an extra bedroom to accommodate their growing family. The husband was subsequently transferred interstate in November 1993 and the property was rented at this time. The couple purchased another property which they elected to treat as their main residence. The property was sold in January 2003.

Why is this important? In determining the capital gain the taxpayer may include the costs associated with the renovation. In this instance, the taxpayer failed to keep accurate records (i.e. receipts for the renovations, building contracts, plans or additional loan information), therefore they were unable to substantiate these costs and could not include them in the cost base in calculating their capital gain.

 "The other key thing that we see is around the fact that people continually use the date of settlement when working out a capital gain instead of the date they entered into the contract, and that can make a significant difference because they can be in different financial years," says Dennis-Carter.

Example:
A taxpayer purchased a property on July 7, 2002. The property was sold under a contract entered into on June 30, 2003 with settlement occurring on July 30, 2003. The property was rented for the entire period of ownership.

Why is this important? The taxpayer claimed that they intended to declare the capital gain in the 2004 year, believing that the capital gains tax obligation was calculated at the date of settlement, as opposed to contract date. The capital gain tax obligation therefore should have been declared in the 2003 year. Furthermore, as the property was purchased and sold within a 12-month period (contract to contract date), the taxpayer was unable to apply the 50 per cent discount in calculating the gain.

"In terms of deductions more generally, one of the things that people need to be aware of is that there are some things that they can deduct on a year-by-year basis but there are other things that they can only include when they calculate their cost base for capital gains tax purposes," Dennis-Carter says. "They can't actually claim them as a deduction on their tax return.

"Anything that relates to an acquisition or disposal cost needs to be included in the calculation of the cost base of the property."

Example:
A taxpayer purchased a property in June 1998 and sold it in April 2003. The property was an investment property for the entire period of ownership. In his income tax returns from 1999 until 2003 he claimed rates and insurance premiums. When calculating his capital gain to be included in his 2003 return, he included these rates and insurance premiums as part of the cost base.

Why is this important? If a property is used for income-producing purposes these items are deductible expenses. These items cannot be used to reduce the cost base.

As Dennis-Carter reminds new investors, when you buy a property specifically for investment there are extra tax benefits, as opposed to if you convert a property that was originally your home to an investment property.

"The key tax benefits around investing in property are, firstly, the fact that you can claim deductions for interest that you incur on any loan that you've taken out to purchase the investment property," she says.

"Generally that's referred to as negative gearing, but people are only entitled to that if the purpose of the loan was to purchase an investment property.”

It's not as black and white, she says, if you've paid off your own home and decide to buy a new home and convert your current home into an investment property.

"(If) you borrow money to buy your new home and you use the home that you previously lived in as security for that loan, even though you're now renting out that home, because the purpose of the loan is actually to buy your new home that you're going to live in, you're not entitled to claim the interest," Dennis-Carter explains.

"People just need to be aware of that. If you go out and purchase a home particularly for investing and you borrow money, then you're certainly entitled to claim the interest as a deduction and often people will end up in a negative gearing situation which obviously is of help in terms of their tax, but in the other circumstance, you're not going to be able to do that."

For investors with a tenanted property, there are deductions that they are entitled to relating to the cost or expenses of holding that property.

"They can be things like advertising for tenants, rates, insurance, body corporate fees and bank charges. They're also entitled to claim depreciation for items that are in the house. That could be for example, curtains, carpet, and light fittings," says Dennis-Carter.

The ATO is currently zeroing in on rental deductions and capital gains with the tax returns being processed from the past financial year.

"What we will be looking at in terms of rental deductions are things like whether people are claiming a deduction for something which they're claiming as a repair when it's actually a capital improvement," says Dennis-Carter. "For example, we see things like people adding pergolas or carports on rental properties and claiming them as a repair when they're actually a capital improvement.

"(Property investment) is one of the areas that we are focusing on because we are seeing such a significant increase in the number of people making claims or declaring income from rental properties, and also obviously because of the significant upturn in the market, we're expecting to see much more significant capital gains declared as well. So in the context of that, we believe that's an area that we should be focusing on.

"In terms of capital gains for the 04-05 year, we will be looking at around 6000 cases initially with an expectation that that will lead to about 3000 targeted audits.

"We will be sending a letter to...around 22,000 people who purchased an investment property last year just alerting them to their capital gains tax obligations at the point in time that they do dispose of their property.

The other thing that we're doing is that we have significantly increased our data matching capability around real estate property information and on that basis, we have already identified around 5000 taxpayers who appear to have made large capital gains who we'll be sending letters to, reminding them that they need to declare those capital gains in their tax return," Dennis-Carter said.
For more information about investment properties and taxation, visit www.ato.gov.au

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Depreciation
Independent valuer Herron Todd White estimates that up to 70 per cent of property investors don't know about the benefits available to them in getting a tax depreciation schedule for their investment property - whether it be residential or commercial.

HTW project director Phil Grahame says failure to obtain a tax depreciation schedule results in reduced cash flow and real loss of income from your investments to which you are entitled.

"A quantity surveyor can prepare a schedule with current depreciation information for your accountant to ensure you receive the maximum depreciation allowable through your tax return," Grahame says.

"The cost of having a depreciation schedule prepared is in itself tax deductible and is usually recouped in the first year's tax return, allowing you to pay less tax from year one.

"A common misconception held by many potential investors is that only new buildings attract depreciation. However, and this is the key, each investment property contains a number of depreciable assets such as removable floor coverings, stoves and cooktops, air conditioning units, hot water systems, curtains and blinds, dishwashers, and swimming pool filtration and cleaning systems."

Grahame says any building built after July 18, 1985 qualifies for the 'special building write-off' which means investors can claim depreciation on the original construction cost of the building.

"A schedule can be prepared that is backdated by up to five years, "he says. "Amendments to your previous tax returns can be made, allowing you to access five years of depreciation in one year."

Ten tips
1. Think twice before crossing the border
Wells has a warning for investors who are considering venturing interstate.
"They're probably out of their knowledgeable area and they should certainly do their research and get to know the local marketplace before making a decision on acquiring," he advises.

2. Be prepared
Keep proof of all you spend to ensure you don't pay more tax than you need to over the years. The ATO says you need to separately identify the cost of the building and any depreciating assets so you can claim all the deductions you are entitled to and work out your capital gain correctly when you sell.

3. Surf the web
Henderson suggests using the internet to communicate with like-minded investors. "That's a place where they can get free homework and free research."  He names the Somersoft forum (www.somersoft.com.au/forum.htm) as a useful online resource. 'They're a little self-help groups,' he says.

The following seven tips come from Mortgage Choice:

4. Seek independent financial and legal advice
There are a number of tax and legal ramifications associated with property investment and it's vitally important for potential investors to seek professional advice from their financial planner, accountant or solicitor before deciding on a strategy.

5. Use the equity in your home
With the recent housing boom and increase in property prices, many homeowners will have a significant amount of equity in their homes that they can tap into to purchase an investment property. 

6. Consider borrowing 110 per cent to cover purchase price and costs
If you have enough equity in your home, you may want to consider borrowing the full purchase price of the property and associated costs - you won't have to save for a deposit and you can claim any rental shortfall on a negative-gearing basis.

7. Carefully consider the options of positive vs negative gearing
Consult with your financial adviser before purchasing an investment property as to whether positively or negatively gearing a property is of greater benefit to your financial needs.

8. Choose the most suitable loan
There are a number of different types of loan available to residential property investors, and the most suitable loan will depend on your investment strategy.

9. Consider interest-only vs principal and interest loans
Think carefully about interest-only vs principal and interest options. Although interest-only loans will not reduce the loan amount, they will result in less monthly repayments and allow you to make greater contributions to your principal place of residence, allowing the investment property to grow in value through capital gains.

10. Take a long-term approach 
As with all investment strategies, a long-term approach should be taken when purchasing an investment property. Unlike the gains achieved on investment properties in the recent boom, borrowers can still expect good returns per year, and depending on market conditions and personal circumstances, may look at holding on to the property for seven to ten years.