The ATO's Focus on Property Investors Deductions

With so many investors purchasing an investment property as part of their investment portfolio, it is advisable to revisit the ATO requirements for permissible deductions for a rental property.

The ATO has revealed that the majority of rental property owners are making errors in their tax returns, either overclaiming their deductions or not reporting their income correctly.

It is important to note that the ATO receives information from various data matching sources. This includes banks, the land titles office, insurance companies and property managers.  It then cross-checks the information provided in the tax return against the information received from data matching.

Deductions Mistakes

Deductions can only be claimed to the extent that they are incurred in producing the rental income. 

One of the most common errors is claiming the full amount of interest on a mortgage where funds have been withdrawn from that mortgage for personal or non-property related expenses.  For example, if an investment property has a mortgage of $650,000 and there is a withdrawal of $20,000 for a family holiday or some other personal expense, then all the interest on the mortgage can no longer be claimed. Only interest on the mortgage of $650,000, not on the full amount of $670,000, can be claimed.

An additional common error is claiming a deduction for a special body corporate levy. Body corporate levies are claimable if they are levies for routine maintenance of common property, but if a special levy is required to be paid for a particular capital expenditure, then it cannot be claimed until the capital works are complete.

In most states and territories, stamp duty on the purchase of an investment property cannot be claimed against rental income but must be added to the purchase price of the property to form part of the cost base. The exception to this is in the ACT, where stamp duty can be claimed against the rental income. Generally, stamp duty reduces any capital gain you may have when you sell the property. However, borrowing expenses such as loan establishment fees can be claimed, but not as a deduction when the loan is taken out; rather, they are claimed over 5 years or the life of the loan – whichever is shorter.

When carrying out repairs on a rental property, consideration needs to be given as to whether it is a repair or a capital expense.  For example, repairing a ceiling fan in a rental property would be claimable outright, but if replacing the fan, it would need to be depreciated.

The ATO gives the following definitions for these expenses:

• Repairs and general maintenance are expenses for work done to remedy, or prevent, defects, damage or deterioration from using the property to earn income. These expenses can be claimed in the year the expense occurred. 

• Initial repairs include any work done, including fixing defects, damage or deterioration existing at the time of purchase, regardless of whether your client knew about the need for repairs at the time they acquired the property. These are capital repair expenses and can't be claimed as a deduction. Instead, initial repairs are part of the acquisition cost and included in the cost base of the property for CGT purposes, unless they are 

• capital works
• depreciating assets
• Capital works are structural improvements, alterations and extensions to the property: 

• claimed at 2.5% over 40 years, with some exceptions
• can only be claimed after the work has been completed, regardless of when your client pays a deposit or pays the bill in instalments.
• Improvements or renovations that are structural are also capital works. Work going beyond remedying defects, damage or deterioration and improving the function of the property is our improvement. 

• Repairs to an 'entirety' are capital and can't be claimed as repairs. Repairs to an entirety generally involve the replacement or reconstruction of something separately identifiable as a capital item, for example, a depreciating asset. 

• Depreciating assets (capital allowances) must be claimed over time according to their effective life.

Keeping Detailed Records

Detailed records need to be kept for all deductions claimed, and if any expenses are allocated, then the calculations need to be kept on how that apportionment was worked out. The ATO require that records be kept for 5 years from the lodgement of the tax return.

If a property is a holiday home and there are periods that it is not available for rent because it was being used by the owner for their personal holiday, then expenses will need to be distributed so that the amounts claimed are only for the time that it was available to be rented.

To minimise errors, it is recommended to understand the ATO compliance requirements for rental properties. If you require assistance or wish to discuss any issues surrounding your rental property, we’re here to help.

Reach out to Oracle Accounting & Tax Advisers Accountant today!

Written by Dona Pinkowski
Senior Accountant
Oracle Accounting & Tax Advisers - Erina

Important information – Oracle Advisory Group makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation or needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek their own professional advice. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.