Income, interest and capital works deductions: What property investors need to know to steer clear of the ATO

The ATO revealed that, in the previous financial year, over 1.8 million Australians with rental properties claimed $38 billion in deductions.

However, assistant commissioner Tim Loh revealed that the ATO adjusted more than 70 per cent of the 2019-20 returns selected for review.

Mr Loh said that the most common mistake that Australians with a rental property make is to fail to declare their income. 

“To put it simply, you should expect tax consequences for any property that you earn income from that isn’t your main residence,” he warned.

Mr Loh said the ATO is expanding its reach when it comes to rental income data collection, working with numerous third-party sources like gig economy platforms, rental bond authorities and property managers. 

The ATO is on the lookout for taxpayers who fail to disclose all of their income in their tax return, Mr Loh said.  

“The ATO often allows taxpayers who have made genuine errors to amend their returns without penalty. But deliberate attempts to avoid tax on rental income will see the ATO take action,” he said.

“People should remember that there’s no such thing as free real estate when it comes to their tax returns. Our data analytics scrutinise returns for rental deductions that seem unusually high. We will ask questions, and this may lead to a delay in processing your return.” 

According to Mr Loh, “most people we contact about their rental deductions are able to justify their claims. However, there are instances where we have to knock back claims where taxpayers didn’t keep receipts, claimed for personal use, or claimed for ineligible deductions.”

Two other things that the ATO is keeping an eye on when it comes to the tax returns of property investors are interest rates and claims for capital works. 

Mr Loh noted that while the interest on a loan used to buy and rent a property at market rates can usually be claimed as tax-deductible, taxpayers can’t treat the interest on that part of the loan as a deductible if they’ve chosen to redraw money from their mortgage for personal use. 

He said that the ATO takes a similarly discerning approach when it comes to capital works-related deductions. 

While the cost of necessary repairs or maintenance needed to address wear and tear are immediately tax-deductible, improvements like a kitchen renovation may not be. 

Mr Loh recommended taxpayers seek advice or use their website in order to get more clarity around what capital works can and can’t be claimed. 

Lastly, he reiterated some terms and conditions when it comes to claiming lost, reduced or deferred rental income. 

Speaking to Smart Property Investment back in June, CPA senior manager of tax policy Elinor Kasapidis explained that many landlords lost rental income or bookings as a result of COVID restrictions, and “these losses can’t be claimed as a tax deduction”.

“But you can still claim your expenses including interest on deferred loan payments,” she added.

“If you received back payment of rent or an insurance payout for lost rent, this is assessable income and must be included in your return.”

Property investors also need to account for sources of income like rental bond money they are entitled to retain if a tenant defaults on their rent, or they incur maintenance costs.

Ms Kasapidis said that property investors relying on short-term rental platforms like Stayz and Airbnb need to be careful.

“The ATO has an ongoing focus on checking rental deductions and matching reported income against details from real estate agents and online platforms such as Stayz and AirBnb,” she said.