Tax time 101: Expenses that rental property investors can claim

Deductions for expenses can only be claimed by investors whose properties are rented or genuinely available for rent. For properties that are not rented, investors are advised to collect evidence that the property has been advertised for rent, keep the property in good condition to attract renters, set a realistic rental rate and place reasonable tenancy conditions to prove the property’s genuine availability for rental purposes.

Moreover, investors cannot claim deductions for expenses incurred over a period when the property was used for private purposes.

Investors may need to apportion their expenses if the rental property is only available for part of the income year, the property was used for private purposes for part of the income, only part of the property was used for rental purposes or the cost of renting the property is at non-commercial rates.

Expenses deductible immediately

In general, expenses that are deductible immediately are those related to the management and maintenance of the property, including interest on loans. For negatively geared properties, the full amount of rental expenses may be deducted against the investor’s income, both rental-related and personal, such as salary, wages and business income.

Some of the expenses for which you may be entitled to an immediate deduction in the income year that the expense was incurred include the following:

• advertising for tenants
• bank charges
• council rates
• water charges
• land tax
• cleaning
• electricity and gas, annual power guarantee fees
• in-house audio and video service charges
• gardening and lawn mowing
• pest control
• quantity surveyor’s fees
• costs of relocating tenants into temporary accommodation if the property is unfit for occupancy for a period of time
• secretarial and bookkeeping fees
• security patrol fees
• insurance, including building, contents, public liability
• interest expenses, such as the interest charged on the loan used to purchase a rental property, purchase a depreciating asset for a rental property, make repairs to a rental property, finance renovations on the rental property or purchase land on which to build a rental property
• property agent's fees and commission
• repairs and maintenance, or works to make the rental property better, fix defects and damages and minimise the risk of deterioration
• some legal expenses, including the costs of evicting a non-paying tenant, taking court action for loss of rental income and defending a damages claim.
• servicing costs
• stationery and postage
• telephone calls and rental
• tax-related expenses
• water charges

Body corporate fees and charges, interest on loans, land tax, legal expenses, mortgage discharge expenses, repairs and maintenance and travel and car expenses are also deductible under certain conditions. Investors are advised to get in touch with the Australian Taxation Office (ATO) or their tax advisors to determine and ultimately maximise their entitlements.

These expenses can only be claimed as tax deductions if the investor actually incurred them and they are not paid by the tenants of the rental property.

Expenses deductible over a number of income years

These expenses are divided into three types, namely borrowing expenses, amounts for the decline in value of depreciating assets and capital works deductions.

Borrowing expenses include the costs of taking out a loan for a rental property, including:

• loan establishment fees
• title search fees charged by your lender
• costs for preparing and filing mortgage documents
• mortgage broker fees
• stamp duty charged on the mortgage
• fees for a valuation required for loan approval
• lender’s mortgage insurance billed to the borrower

If the loan is obtained halfway through the income year, the deduction for the first year will be apportioned to the number of days in the year that the investor had the loan. For investors who are able to repay the loan early and in less than five years, the balance of the borrowing expenses in the year that the loan is repaid in full can be claimed as a tax deduction.

Borrowing expenses worth over $100 will be spread across five years, while borrowing expenses worth $100 or less are fully deductible in the same income year that they are incurred.

Insurance policy premiums, interest expenses, stamp duty charged on the transfer of the property and stamp duty incurred to acquire a leasehold interest in property are NOT considered borrowing expenses.

Meanwhile, deductions for decline in value of depreciating assets are applicable for new items of ‘plant’ such as air conditioners, stoves, and other items that decline in value due to wear and tear. An amount equal to the decline in value of a depreciating asset held any time during the income year can be deducted during the same year.

There will also be limits on deductions for second-hand depreciating assets installed or used in the residential rental property to derive rental income. Second-hand depreciating assets are those that are previously installed and ready for use. They may have also been used by another entity in a private residence or for non-taxable purposes, unless only occasional.

From 1 July 2017, if the second-hand depreciating asset is used to produce rental income from the residential rental property, investors CANNOT claim a deduction on their decline in value unless they are using the property for business or are considered an exclusive entity. This change applies to depreciating assets acquired on 9 May 2017 at or after 7:30 p.m. and depreciating assets used or installed for private purposes in 2016-17.

If the investor bought a newly built property or a substantially renovated property, they can claim a deduction for the decline of a depreciating asset if no one was previously entitled to a deduction for the asset, no one resided in the property before it was acquired, or the property was acquired within six months of it being built or substantially renovated.

A tax depreciation schedule—a comprehensive report of the claimable deductions on the property—is prepared by a quantity surveyor who works hand-in-hand with the tax office can help investors maximise their entitlements.

When working out deductible expenses on depreciating assets, remember that some items are regarded as part of the setting and not as ‘plants’ or separate assets. When the depreciating asset is fixed to the building or considered as part of the structure, the expense is considered as capital works expenditure.

Capital works deductions are construction expenditure that can be deducted over a period of 25 or 40 years. Investors can only claim deductions once the construction is complete and the property is rented or available for rent. Once available, capital works deductions cannot exceed construction expenditure.

Construction expenditure is the actual cost of constructing the building or extension. Deductions for capital works apply to a building or an extension, alterations and structural improvements to the property.

If capital works deductions are claimed based on construction expenditure, investors cannot use construction expenditure once again to work out other types of deductions, such as the deductions for decline in value of depreciating assets.

Deductions are allowed for expenditure incurred in the construction of a building if the investor contracts a builder to construct the building on their land. Construction expenditures will then include the payment that represents the profit made by tradespeople, builders and architects.

Some costs that may be included in construction expenditure are preliminary expenses such as architect and engineering fees and the cost of foundation excavations, payments to carpenters and other tradespeople for construction and payments for the construction of retaining walls, fences and in-ground swimming pools.

The cost of land on which the property was built, expenditure on landscaping, the cost of clearing the land prior to construction and permanent earthworks that can be economically maintained and are not integral to the installation or construction of a structure are NOT considered as construction expenditure.

If the investor builds the property or extension, the value of their contribution to the works and any notional profit element is NOT considered as construction expenditure. If the property was purchased from a speculative builder, the payment that represents the builder’s profit margin is also NOT allowed to be claimed as a capital works deduction.

Several experts can help investors determine the precise construction expenditure. Among the qualified people for the task are a clerk of works or project organise for major building projects, a supervising architect who approves payments, a builder with experience in estimating construction costs and a quantity surveyor.

Expenses that are not deductible

The expenses that cannot be claimed as tax deductions are:

• costs of acquisition or disposal of the property
• expenses incurred by tenants such as water and electricity charges
• expenses that are not related to the rental property such as the temporary personal use of a holiday home and maintaining a non-income producing property as collateral for the investment loan
• travel expenses for property inspection prior to purchase (travel expenses related to the residential rental property incurred from 1 July 2017 are also non-deductible unless the property is used to carry on a business or the investor is an excluded entity)
• cost of relocating assets between rental properties prior to renting
• cost of rental seminars to help the investor find a rental property

Certain stipulations on borrowing expenses, second-hand depreciating assets and construction costs, as stated above, also refrain investors from claiming tax deductions

Keeping records

Come tax time, investors must be able to work out the income they need to declare and the expenses they can claim and show how they came up with the figures provided. Therefore, they are strongly encouraged to keep important records relating to their asset for an average of five years from the date of the lodgement of the tax return.

Apart from serving as proof of correct information, good records can also help investors ensure that they are able to claim all their entitlements, reduce the risk of tax audits and adjustments, resolve issues relating to disputed assessments and adjustments and avoid penalties. If they are working with a tax adviser, having well-prepared records can also minimise the cost of the management of their tax affairs.

While there is no set list of records to keep, among the types of records that must be kept by investors are:

• payments received such as salary, wages, allowances, rents, interests, dividends, managed funds, government benefits and pensions and other pensions or annuities.
• expenses related to payments received such as car, travel, clothing, self-education and work-related expenses, as well as rental expenses, if any.
• records related to the acquisition or disposal of rental property
• gifts, donations and contributions that are tax-deductible
• disability aids, attendant care or aged care expenses

Receipts and invoices are valid if their show the name of the supplier, the Australian business number (ABN) of the supplier, the amount of expense or purchase, the nature of goods or services purchased or expense incurred, the date when the expense was incurred and the date of the document.

Some of the examples of records to keep are loan documents, receipts for expenses, land tax assessments, credit card records, tenants leases, banks statements and rent records from property managers. These should not be sent in with the tax return and should only be kept in case the ATO requires the investor to present them as evidence.

If records are lost or destroyed, the investor can be allowed to claim deduction for certain expenses if they have a complete copy of a lost or destroyed document or if the ATO is satisfied that they took reasonable precaution to prevent the loss or destruction of the document and that it is not reasonably possible to obtain a substitute document.

At the end of the day, investors are responsible for lodging a tax return that is signed, complete and correct. As such, they are encouraged to engage with professionals, where appropriate, in order to understand their rights and entitlements and meet their obligations as rental property owners.

The responsible lodgement of tax returns will ultimately help investors save time and money while maximising the wealth-creation potential of their property.