Don’t be ‘un-Australian’ at tax time, ATO warns rental property owners

Continuing, Mr Loh said: “When you are overclaiming expenses or claiming for improvements to private properties, you are taking money from the Australian community.

“Money that could have been otherwise used to further increase funding for things like women’s sports, schools and hospitals.”

Investors are advised to take particular care when reporting rental income, rental expenses, interest expenses and repairs, maintenance, and improvements.

Include all rental income

Mr Loh added that property owners need to ensure all rental income is included, such as “income from short-term rental arrangements, renting part of a home, and other rental-related income like insurance payouts and rental bond money retained”.

He explained: “Income and deductions must be in line with a rental property owner’s ownership interest, which should generally mirror the legal documents.”

The ATO outlined that rental income must be reported:

• in the year the tenant pays (and not when your agent or property manager transfers it to you)
• as the gross amount is received (before property management fees and other expenses paid for by your property manager on your behalf are taken out)

When reporting rental income, property owners are not to “double dip their deductions”.

As advised by Mr Loh: “Make sure you are declaring your gross income.

“We have seen some clients declaring their net rental income after the property manager has paid their expenses and then they have claimed deductions like rates and repairs all over again.”

The three categories of rental expenses

The ATO has flagged three categories of rental expenses as they apply to residential landlords:

1. Expenses where deductions cannot be claimed – such as personal expenses, including expenses arising from personal use of the property.

This also includes expenses of a capital nature, such as second-hand depreciating assets.

2. Expenses where an immediate deduction can be claimed in the income year the expense is incurred – including interest on loans, council rates, repairs and maintenance, as well as depreciating assets that cost $300 or less.
3. Expenses where deductions can be claimed over a number of years – including capital works, borrowing expenses, and the decline value of depreciating assets (where specific criteria is met).

An eye on interest expenses

This financial year, the ATO is “particularly focused on interest expenses and ensuring rental property owners understand how to correctly apportion loan interest expenses where part of the loan was used for private purposes (or the loan was re-financed with some private purpose)”.

Mr Loh revealed that approximately 80 per cent – or four in five taxpayers with rental income – “claimed a deduction for interest on their loan”.

It’s also the area where the Assistant Commissioner said the ATO is “seeing the biggest mistakes”.

“You can only claim interest on a loan used to purchase a rental property to earn rental income,” he indicated.

“If you’ve used any part of your original or refinanced investment property loan to cover private expenses, like buying a new car or renovating the home you live in, you can only claim an interest deduction for the portion relating to producing your rental income.”

Turning attention to repairs, maintenance and improvements

To give investors more insight into the tax process, Mr Loh also explained the different ways repairs, maintenance and improvements can be claimed.

“When you first acquire a rental property and it needs work done to get tenants in – for example, you need to fix a hole in the wall or some damaged floorboards – these are initial repairs,” he outlined.

The ATO acknowledged that initial repairs to rectify damage, defects or deterioration that existed at the time of purchasing a property cannot be claimed as an immediate deduction, but may be claimed as capital works deductions over a number of years.

This is different to the performance of general repairs and maintenance where an investor has owned their rental property for a number of years; these repairs are immediately deductible.

Mr Loh went on to clarify: “You can claim an immediate deduction for general repairs like replacing a broken light globe or window. But if you rip out an old bathroom and put in a new and improved one, this is a capital improvement and is deductible over time as capital works.”

What about short-term rentals? And holiday homes?

The Assistant Commissioner acknowledged that many Australians own short-term rental properties such as holiday homes that they rent out for most of the year “and use it occasionally themselves”.

If this is the case, the ATO advised that you need to apportion your deduction for rental expenses when the property (or part of it) is not being used to produce rental income.

This includes:

• when an investor uses it personally or reserves it for friends or family, or
• when an investor places unreasonable conditions on a short-term holiday let that restricts the likelihood of the property being rented (including excessive rates, requiring of references for prospective tenants, or conditions such as “no children” in a family friendly destination)

Mr Loh said: “You need to make sure you have the records to demonstrate you incurred expenses for your rental property and the extent they relate to producing rental income.”

When it comes to “mates’ rates”, the Assistant Commissioner advised that “you can only claim for expenses up to the amount of income you’ve received”.

Short-term rentals is an area the ATO is “paying close attention to this year”, Mr Loh stressed.

“If you’ve made genuine mistakes, we encourage you or your registered tax agent to fix any errors or omissions in your tax return as soon as you can. If you are deliberately overclaiming, it is un-Australian and penalties will apply,” he warned.

Don’t get caught out with data matching

The latest comments from Mr Loh come as the ATO reminds property investors of its “sophisticated data matching capabilities”, which incorporates residential investment property loans (RIPL) and landlord insurance (LI) data matching.

Mr Loh stated: “This new data provides us with crucial intelligence to paint a picture of what’s true and accurate in tax returns, and we continue to expand our data-matching capability to ensure income and deductions are correctly reported.”

For more insights, discover eight of the best EOFY tax tips for landlords.