Top 10 tips – common mistakes rental property owners make:
1. Apportioning expenses and income for co-owned properties.
If you own a rental property with someone else, you must declare rental income and claim expenses according to your legal ownership of the property. As joint tenants your legal interest will be an equal split, and as tenants in common you may have different ownership interests.
2. Make sure your property is genuinely available for rent:
Your property must be genuinely available for rent to claim a tax deduction. This means:
- you must be able to show a clear intention to rent the property.
- advertising the property so that someone is likely to rent it and set the rent in line with similar properties in the area.
- avoiding unreasonable rental conditions.
- Be aware that any related party discounts may limit your tax deduction. For example if you rent your property at a discount to your parents or children.
3. Getting initial repairs and capital improvements right:
Ongoing repairs that relate directly to wear and tear or other damage that happened as a result of you renting out the property can be claimed in full in the same year you incurred the expense. For example, repairing the hot water system or part of a damaged roof can be deducted immediately. Initial repairs for damage that existed when the property was purchased, such as replacing broken light fittings and repairing damaged floor boards are not immediately deductible. Instead these costs are added to your cost base and used to work out your capital gain or capital loss when you sell the property. Replacing an entire structure like a roof when only part of it is damaged or renovating a bathroom is classified as an improvement and not immediately deductible. These are building costs which you can claim at 2.5% each year for 40 years from the date of completion. If you completely replace a damaged item that is detachable from the house and it costs more than $300 (eg replacing the entire hot water system) the cost must be depreciated over a number of years.
4. Claiming borrowing expenses:
If your borrowing expenses are over $100, the deduction is spread over five years. If they are $100 or less, you can claim the full amount in the same income year you incurred the expense. Borrowing expenses include loan establishment fees, title search fees and costs of preparing and filing mortgage documents.
5. Claiming purchase costs:
You can’t claim any deductions for the costs of buying your property. These include conveyancing fees and stamp duty (for properties outside the ACT). If you sell your property, these costs are then used when working out whether you need to pay capital gains tax.
6. Claiming interest on your loan:
You can claim interest as a deduction if you take out a loan for your rental property. If you use some of the loan money for personal use such as buying a boat or going on a holiday, you can’t claim the interest on that part of the loan. You can only claim the part of the interest that relates to the rental property.
7. Getting construction costs right:
You can claim certain building costs, including extensions, alterations and structural improvements as capital works deductions. As a general rule, you can claim a capital works deduction at 2.5% of the construction cost for 40 years from the date the construction was completed. Where your property was owned by someone else previously, and they claimed capital works deductions, ask them to provide you with the details so you can correctly calculate the deduction you’re entitled to claim. If you can’t obtain those details from the previous owner, you can use the services of a quantity surveyor to prepare what is called a QS report. This report will provide the details you need to claim the correct depreciation write-offs.
8. Claiming the right portion of your expenses:
If your rental property is rented out to family or friends below market rate, you can only claim a deduction for that period up to the amount of rent you received. You can’t claim deductions when your family or friends stay free of charge, or for periods of personal use.
9. Keeping the right records:
You must have evidence of your income and expenses so you can claim everything you are entitled to. Capital gains tax may apply when you sell your rental property. So keep records over the period you own the property and for five years from the date you sell the property.
10. Getting your capital gains right when selling:
When you sell your rental property, you may make either a capital gain or a capital loss. Generally, this is the difference between what it cost you to buy and improve the property, and what you receive when you sell it. Your costs must not include amounts already claimed as a deduction against rental income earned from the property, including depreciation and capital works. If you make a capital gain, you will need to include the gain in your tax return for that income year. If you make a capital loss, you can carry the loss forward and deduct it from capital gains in later years.
Other issues that need to be considered
Owners of properties being rented or are ready and available for rent can claim immediate deductions for a range of expenses such as:
- interest on investment loans
- land tax
- council and water rates
- body corporate charges insurance
- repairs and maintenance
- agent’s commission
- pest control
- leases – preparation, registration and stamp duty
- advertising for tenants.
Landlords may be entitled to claim annual deductions for the declining value of depreciable assets such as stoves, carpets and hot-water systems. This includes capital works deductions spread over a number of years for structural improvements, like remodelling a bathroom.
Last year changes were made that denied landlords the travel costs relating to inspecting, maintaining or collecting rent for a rental property.
Further to this, deductions for the depreciation of plant and equipment for residential real estate properties are limited to outlays actually incurred on new items by investors in residential real estate properties. For example, properties acquired from 9 May 2017, landlords can no longer depreciate assets already in the property at the time of purchase. However, should they purchase a new – not used or refurbished – asset, they can depreciate that asset.
Plant and equipment forming part of residential investment properties as of 9 May 2017 will continue to give rise to deductions for depreciation until either the investor no longer owns the asset, or the asset reaches the end of its effective life.
Ensure interest expense claims are correctly calculated and rental income is correctly apportioned between owners. This includes claims for costs to repair damage or defects at the time of purchase are depreciated and holiday homes are genuinely available for rent.
Deductions for vacant land
Changes to legislation to limit deductions claimed for holding vacant land, received royal assent on 28 October 2019. These changes apply to costs incurred on or after 1 July 2019, even if the land was held before that date.
Deductions for expenses incurred for holding costs of vacant land can continue to be claimed by corporate tax entities and superannuation funds other than self-managed superannuation funds. Managed investment trusts, public unit trusts and unit trusts or partnerships where all the members are the previous entity types.
There are some entities and circumstances where deductions for vacant land can still be claimed. For example, where the entity holding the land is a company, where you use the land in carrying on a business, or exceptional circumstances apply. Expenses of holding land remain deductible if they are incurred in carrying on a business such as farming or gaining or producing assessable income.
The ATO has produced a flowchart to assist in determining if deductions for expenses related to vacant land are limited.
Residential property and non-residents
A change in law on 12 December 2019 means if you are a foreign resident for tax purposes at the time you dispose of your residential property in Australia, you will not qualify for exemption from CGT unless you satisfy the life events test.
For properties held before 7.30pm (AEST) on 9 May 2017, the CGT main residence exemption will only be able to be claimed for disposals that happen up until 30 June 2020, provided the taxpayer satisfies the other existing requirements for the exemption.
For more information or help in preparing your income tax return please contact Encore Accounting 33 Jeays Street Bowen Hills Telephone 07 3257 7777. It is simply not worth getting this complicated area wrong.
Written by Allan Mason – Chartered Accountant
Founder of Encore Accounting Pty Ltd and Broadview Publishing
Author of :
Survival to Success – How to Play and Win the Game of Life
Business Bullseye – How to Succeed in Business
How to Choose an Accountant – Your most valuable team member.