Rental properties – keeping deductions working for you

If you own a rental property you could be one of the 110,000 investors who will be getting a letter from the Australian Tax Office (ATO) about your tax liabilities.

The ATO has 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.

Daniel Deutsch is a partner at Marin Accountants, a firm specialising in advice for individuals, investors and family businesses. 

This piece originally appeared at Property Observer.