Earlier this year the Australian Taxation Office (ATO) announced that they would double the number of audits being conducted into rental properties. In 2017/18 more than 2.2 million taxpayers claimed $47 billion in deductions. Assistant Commissioner Gavin Siebert advised that in order to target potential overclaiming they would:
“use a range of third party information including data from financial institutions, property transactions and rental bonds from all states and territories, and online accommodation booking platforms, in combination with sophisticated analytics to scrutinise every tax return. Where we identify claims of concern, ATO staff will investigate and prompt taxpayers to amend unjustifiable claims. If necessary, we will commence audits”
What can you do this tax time to make sure that if you are one of the “lucky” 4,500 taxpayers who will get a please explain letter from the ATO, you have the confidence that you are claiming everything you’re entitled to without falling foul of the law?
Firstly on the income side. You must declare all income earned from the property. If it’s listed through an agent, this is easy. If you let your property directly, then regardless of whether the income is received as cash or though a bank account, it must be declared. If a property is jointly owned, it is necessary to declare income and claim deductions in the same proportion as the legal interests in the property.
Moving to expenses. The overarching principal to keep in mind is that deductions can only be claimed to the extent that they relate to producing assessable income. Expenditure which is for private purposes can never be claimed. If you use a rental property for private purposes (eg as a holiday home) in addition to earning income, then you must apportion the expenditure between private and deductible purposes. Importantly, it isn’t necessary for the property to be rented out to claim the deductions, but the property must be available for rent. As an example, if you own a property in a prime beachside location, and you only make the property available to family and friends who pay a token rent, expenses are not deductible.
The biggest deductible item is interest, so lets focus here first.
You can only claim the interest on your mortgage NOT the repayments. Unless you are on an interest only loan, all repayments will have an interest and capital (loan repayment) component. It’s only the interest that is deductible. Your bank will normally issue a summary after the end of the financial year of how much you have paid.
The tricky part comes if your loan is not fully deductible.
Consider the following scenarios:
| What if you… | Is the interest Deductible? |
| Have a line of credit that your pay is deposited into and you use for paying day to day expenses as well as expenses associated with the property. The finance was originally taken out to fund the rental property. | Not fully. You must apportion the interest between the personal and rental related expenditure. |
| Have a line of credit that your pay is deposited into and you only use it to pay for expenses associated with your rental property (eg rates, insurance, repairs etc). | Yes in full. There is no private use of the facility. |
| Own a holiday home which your family use over school holidays | Not fully. You must apportion the time the property is available for rent and only claim that amount. |
| Lived in a property but decide to move into a bigger home. You keep the original property to rent out and redraw on your loan to assist with buying the new property. | Not fully. The interest on any drawdown not used for income producing purposes cannot be claimed, regardless of which property is security for the loan. |
| Redraw on your mortgage to pay for renovations to your rental property | Yes in full. There is no private use of the loan. |
| Redraw on your mortgage to buy a new car. | Not fully. The interest on the proportion of the loan used for private purposes cannot be claimed. |
The best advice I can give is to keep your deductible and non deductible loans separate. That is, wherever possible, only use a loan set up for your investment property for expenses related to the property and have a separate arrangement for your private expenditure. It makes tax time so much simpler!
The next biggest focus of the Tax Office is repairs. The general rule is that repairs and maintenance are tax deductible in the period when you spend the money. But where it becomes tricky is if something is not considered a repair for tax purposes. Think about a kitchen renovation. You might have to replace the sink, put in entirely new cupboards, replace the dishwasher, stove and cooktop, do some painting and replace the floor. In this case, you are essentially replacing the entire kitchen. Normally, this wouldn’t be considered a repair but is a capital cost. On the other side, say you just replaced some broken doors on the cupboards, fixed the leaking taps and gave everything a coat of paint. This would be considered repairs and deductible when incurred. The difference comes down to what is being replaced and the extent to which it is being improved. If it’s an entire element of the house (in this case the kitchen), it will be capital and not be immediately deductible. You may however, be able to claim depreciation on the expenditure (that is, claim a portion each year over the life of the asset). You can imagine, there’s a lot of shades of grey and off white in between, so it might pay to talk to a professional!
One other area with a few shades of grey are in relation to strata levies (especially topical if you own an apartment in Sydney!). The usual ongoing strata levies are clearly deductible. However if you have an ad hoc special levy which is being used to complete capital works in the building, these will not be deductible. Instead they must be added to the cost base of the asset and claimed against any capital gain on sale.
Other areas of expenses are much easier to get right. Rates, water, insurance, pest inspections, agent fees, etc are all deductible when they are paid. Of course, if the property is used partly for private purposes, these expenses also must be apportioned.
It’s important to note that since 1 July 2017 you are no longer able to claim expenses to visit your rental property. From the same date, you are also unable to claim deductions for depreciation of second hand assets. This especially affects you if you purchase a property. You are no longer able to claim depreciation on the assets already installed when you purchase the property.
If you have further questions about how to get your investment property claim right the first time, I’m more than happy to chat with you and offer a FREE 30 minute initial consultation. You can easily book online here and I look forward to helping you sort your taxes!