Getting your tax return done right is very important to ensure you get every tax advantage you deserve. You can claim a lot of your expenses, but the ATO watches carefully, and they are remarkably good at detecting false or “unsubstantiated” claims. Let’s cover some basics to help ensure you get the tax deductions you deserve for your holiday rental property, and that you claim your expenses the right way.
What are the rental expenses you can claim now?
You can generally claim an immediate deduction against your current year’s income for your expenses related to the management and maintenance of the property, including interest on loans.
If your property is negatively geared, you may be able to deduct the full amount of rental expenses against your rental and other income, such as salary and wages and business income.
Expenses you claim this year
You can claim a deduction for these expenses only if you incur them and the tenant does not pay them.
Expenses you may be entitled to claim an immediate deduction for in the income year you incur them include:
- advertising for tenants
- body corporate fees
- council rates
- water charges
- land tax
- gardening and lawn mowing
- pest control
- insurance (building, contents, public liability)
- interest expenses
- pre-paid expenses
- property agent’s fees and commission
- income protection insurance
- repairs and maintenance
- some legal expenses.
If you take out a loan to purchase a rental property, you can claim a deduction for the interest charged on the loan or a portion of the interest. However, the property must be rented out or genuinely available for rent in the income year you claim a deduction.
What you can claim
You can claim the interest charged on the loan you used to:
- purchase a rental property
- purchase a depreciating asset for the rental property (for example, to purchase an air conditioner for the rental property)
- make repairs to the rental property (for example, roof repairs due to storm damage)
- finance renovations on the rental property, which is currently rented out, or which you intend to rent out (for example, to add a deck to the rear of the rental property)
- You can also claim the interest you have pre-paid up to 12 months in advance.
What you can’t claim
You can’t claim a deduction for interest expenses you incur:
- for any period you used the property for private purposes, even if it’s a short period of time
- on the portion of the loan, you use for private purposes either when you took out the loan or if you refinanced (for example, the money you use to purchase a new car or invest in a super fund)
- on loan, you used to buy a new home if you don’t use the new home to produce income, even if you use your rental property as security for the loan
- on any portion of the loan, you use for private purposes, even if you are ahead in your repayments.
Rental Property Owners: Tips to Avoid Common Tax Mistakes
The ATO is reminding rental property owners that each year it sees some fairly common mistakes being made with tax claims made and the outcomes that result, in regard to investment properties. The Australian Taxation Office (ATO) is warning rental property owners that it sees some reasonably common tax mistakes made with investment property claims.
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.
Partners carrying on a rental property business
Most rental activities are a form of investment and don’t amount to carrying on a business. But if you’re carrying on a rental property business in partnership with others, you must divide the net rental income or loss according to the partnership agreement. If you don’t have a partnership agreement, you should divide your net rental income or loss between the partners equally.
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.
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.
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.
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.
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 qualified professional who can estimate previous construction costs.
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 floorboards, are not immediately deductible. Instead, these costs are 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 that 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 (for example, replacing the entire hot water system) the cost must be depreciated over a number of years.
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.
Keeping the right records
You should keep records for every transaction and event affecting your investment property for the entire period of ownership of your property and for at least five years since the date of lodgement of your tax return for the year in which you dispose of it.
Your client must have evidence of their income and expenses so they can claim everything they are entitled to. 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.
Make sure your property is genuinely available for rent
Your client’s property must be genuinely available for rent to claim a tax deduction. This means they must be able to show a clear intention to rent the property. Advertise the property so that someone is likely to rent it and set the rent in line with similar properties in the area. Advise them to avoid unreasonable rental conditions.
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.
Tips for Rental Property Owners
The records you need to keep, depending on your circumstances, may include:
Get Depreciation Report from a Quantity Surveyor
A Quantity Surveyor is a specialist who can estimate the value of construction works and depreciable items to produce a report outlining the amounts of capital allowances you can claim in each year for those items if you rent your property.
You can generally benefit from claiming a deduction on capital works (building) if the residential property was built after 15 September 1987. The costs of building are claimed over 40 years from the date the construction was complete at 2.5% per year (for example, if the initial costs of building are $350,000, you can claim 8750 per year).
If you acquire a newly built property, you are also eligible to claim deduction on depreciable items, also known as plant and equipment. These are items that have limited effective life and can be easily removed from the property, such as appliances, hot water systems, security systems, air conditioning assets, etc. The amount of claim depends on the effective life of these assets.
By claiming capital allowances, you can get the benefits of significant tax deductions without making any cash outgoing (since the costs were already included in the purchase price of the property).
Before using a Quantity Surveyor, you should check if they are accredited by the Australian Institute of Quantity Surveyors and are registered as Tax Agent with the Tax Practitioners Board (TPB).
Keep Good Records
Acquiring the property:
- Contract of purchase or transfer documents
- Settlement statement
- Stamp duty paid on acquisition
- Invoices for legal fees and other expenses paid on the purchase
- Property loan details, including any loan set up costs
- Complete bank statements for the property loans
- Rates, strata levies and Land Tax paid on the property
- Property insurance costs
- Records of any other costs or receipts (e.g. costs of legal disputes, insurance payouts)
(keep the records of these expenses even for the periods your property is not available for rent as it may affect the property cost base for CGT)
Renovating and repairing your property:
- Invoices for remedial repairs and maintenance works
- Invoices for major renovation, construction and improvements costs
- Invoices for landscaping and earthwork
- Invoices for garden maintenance
- Invoices for any items purchased for your property
(Make sure the invoices contain a detailed description of the work performed. Ask your supplier to itemise the invoice where possible)
Renting out your property:
- The date the property first started earning assessable income
- Starting and ending dates of the periods the property was rented out, used as your main residence or used for any other purpose
- Depreciation and capital works deductions claimed against rental income
Selling your property:
- Sale contract and settlement statement
- Invoices for legal fees, marketing costs and agent sale commission
- Invoices for renovation, styling and other expenses paid to sell the property.
Keep your investment property loans “clean”
The amount of interest you can deduct against your rental income (or capitalise as a part of the cost base) is limited to the extent the money borrowed was used to acquire, renovate and maintain the property. If part of the loan was used for other purposes, the portion of interest relating to that part might not be deductible.
While mixed-purpose loans may be a commercial reality, they may restrict your ability to manage the loan balances relating to each of the purposes. Generally speaking, repayments you make on such loans will be allocated proportionally. You cannot choose which particular balance you want to repay first.
Making frequent drawdowns on property loans for unrelated purposes may add up to the tax compliance costs as your accountant will have to spend time to calculate the apportionment every month.
Obtain Market Valuation of your property if necessary
Suppose you start renting out the property that was used as your main residence since the acquisition. In that case, you are deemed to acquire it on the day it first started to produce assessable income at Market Value on that day (if it occurred after 20 August 1996). When this happens, you may need to obtain Market Valuation to establish the cost base of your property.
Other situations where you may need to obtain market valuation include:
- You acquired your property for no consideration (e.g. as a gift)
- You inherited your property, and the property was acquired by the deceased before 20 September 1985.
- The property was acquired from or sold to a related party (e.g. family or friends).
- You change your intention to hold the property as an investment asset for generating rental income and decide to undertake development and/or subdivision for sale.
- You were a non-resident or a temporary resident owning an investment property in Australia for a period of time before 8 May 2012.
For Capital Gain Tax purposes, you should use a professional qualified valuer. The ATO does not accept property sale price indications or other informal valuations as proper evidence. A market valuation can be done retrospectively.
Pay as you go instalments and withholding
If you make a profit from renting your property, you may need to make payments as you go (PAYG) instalments towards your expected end-of-year tax liability.
Generally, you need to pay PAYG instalments if:
- you reported gross business or investment income (including rental income) of $4,000 or more (or $1 for foreign residents) in your most recent income tax return; and
- the tax outstanding on your income tax assessment is more than $1,000.
If your property is negatively geared (that is, has more expenses than profits), you may be able to reduce how much tax is deducted from your regular salary or wages (the PAYG withholding rate). This can help better match your end-of-year tax liability (rather than paying too much throughout the year).
If you believe you need to reduce your PAYG withholding rate, you can apply to us for a downwards variation.
The Australian Taxation Office (ATO) has offered a set of guidelines for rental property owners whose incomes have been recently affected by coronavirus, bushfires, floods or other events during the financial year.
ATO Assistant Commissioner Karen Foat said whatever the circumstances, the most important first step was to keep records of all expenses.
The ATO said you should include rent as income at the time it was paid, so you only needed to declare the rent you had received as income.
If payments by your tenants are deferred until the next financial year, the agency said you did not need to include these payments until you received them.
While rental income may be reduced, owners will continue to incur normal expenses on their rental property. They will still be able to claim these expenses in their tax return, as long as the reduced rent charged is determined at arms’ length, having regard to the current market conditions.
For 2020, expenses for holding vacant land are no longer deductible for individuals intending to build a rental property on that land, but the property is not yet built.
The ATO said this did not apply to land that was used in a business, or if there had been an exceptional circumstance like a fire or flood leading to the land being vacant.
If the property was destroyed in the bushfires and you are currently rebuilding, you can claim the costs of holding your now vacant land for up to three years whilst you rebuild your rental property.