Rental properties - keeping deductions working for you

The ATO has recently announced that it will be writing to a sample of rental property owners about their tax obligations and entitlements, after new data mining technology identified that property investors may have submitted incorrect tax claims in prior tax years.

The ATO are targeting aggressive expense deductions and particularly the estimated two thirds of property investors who are negatively gearing their investments and claiming losses on their investment properties to offset their tax bills.

If you fall into this category, the following tips might be worth considering when you are completing your tax return.

What’s the status of the property?
Firstly, it’s vital that, if you’re claiming deductions, your rental property needs to be rented or available for rent. If a property is not available for rent, then expenses incurred by a taxpayer are not deductible.

This would seem an obvious point, but it’s worth remembering particularly if your property – as a holiday home or other part-time accommodation - is not rented out across the entire year. If that’s the case, remember that you can only claim deductions for the period that the property is rented or available for rent.

Who’s the owner?
It’s also worth remembering that the legal ownership of the rental property determines the proportion of ownership and entitlement to deductions on your individual tax return. This means that if a husband and wife purchase a rental property in joint names, then their levels of ownership will be 50/50 unless stated otherwise in the purchase contract.

Categories of deduction
Generally, the ATO specifies three types of rental property expenses:
•    Those which you cannot claim a deduction.
•    Those which can be claimed as an immediate deduction in the financial year in which they were incurred.
•    Those that can be deducted over a number of years.

Capital or personal expenses aren’t deductible, although you may be able to claim decline in value deductions (depreciation) or capital works deductions, or include certain capital costs in the cost base of the property for capital gains tax purposes. Other examples across each of the three categories are outlined in the sidebar alongside this article.

The picture also gets a bit more complicated when other considerations are factored in. For example, if you take out a loan to purchase a rental property, you can claim the interest charged on that loan as a deduction. However, if the loan is taken out for more than one purpose, you can only claim the interest relevant to the amount borrowed for the rental property. Depending on your circumstances, there may also be potential to claim prepaid interest to maximise your deductions.

Another factor which often confuses owners is the area of repairs and improvements to the property. Spending on repairs and maintenance is tax deductible, but you can’t immediately deduct costs on improvements and total replacements of items, as these are considered capital in nature. However, you might be able to claim depreciation and capital allowances on some improvements.

And, if you’re looking to fix something straight after buying the property, remember that you cannot claim initial repair costs for deterioration and damage already there when you bought the property until at least 12 months after purchase

You should consider getting a quantity surveyor’s depreciation report to ensure you can claim the maximum depreciation and capital allowances deductions. A specialist quantity surveyor can visit your property and prepare a depreciation report that will cover the actual building and the items within it (such as air-conditioner, stove, hot water service, etc).

It’s also worth consulting your accountant before you leap into the property investment space. Given the issues outlined above, tax time can be complex for property investors. When it comes to completing your tax return, working with your accountant to get it right can save a great deal of paperwork – and cost – down the track.

What can you claim now, what can you claim later, and what can’t you claim at all?
1.    Could claim an immediate deduction:
•    Advertising for tenants
•    Agent commissions and fees
•    Bank fees (on rental property loan only)
•    Body corporate fees
•    Cleaning
•    Council rates
•    Electricity/gas (borne by landlord)
•    Gardening/lawn mowing
•    Insurance
•    Interest on loans
•    Land tax
•    Pest control
•    Security fees
•    Repairs and maintenance
•    Stationery, telephone and postage
•    Travel expenses
•    Water bills.

2.    Could deduct over a number of years:
•    Borrowing costs, such as stamp duty, loan establishment fees and title search fees. If less than $100 in total, can be deducted immediately. Otherwise, generally deductible over five years or the term of the loan, whichever is less.
•    Decline in value of depreciating assets (like stoves, refrigerators, air-conditioners, hot water systems). Depreciation claims depend on the item and its effective lifespan (determined by taxation rulings).
•    Capital works deductions - some construction expenditure, including some renovations, extensions and structural improvements can be deducted over a period of time.

3.    Cannot claim:
•    Costs relating to the property’s buying and selling process (these costs are captured when calculating capital gains tax on the sale of the property).
•    Expenses not incurred by owner, such as water or electricity charges paid for by tenants.
•    Expenses unrelated to property rental, such as your own costs when using a holiday home that you rent out for part of the year.

About Daniel Deutsch

Daniel Deutsch is a partner at Marin Accountants, a firm specialising in advice for individuals, investors and family businesses. For more information, contact Daniel at [email protected] or call (03) 9645 9229.