The end of the financial year is rapidly approaching which means it’s nearly tax time.
Investment properties can be great vehicles for building wealth but they can also cost a lot, particularly in the beginning. Luckily, many expenses are claimable as tax deductions.
For those who own a rental property, you’ll want to start pulling together the details of your rental property expenses now in preparation for lodging your tax return.
You can save a lot of money by maximising your tax deductions but it’s essential you have all the details in hand, and fully understand what you can claim – and what you can’t. Especially after the Australian Taxation Office announced rental property income and deductions would be a key focus for them this year.
Tax deductions you can claim on your investment property
Generally speaking, when you purchase an investment property, you can claim a tax deduction for the expenses that relate to the income-producing use of the property. You typically can’t claim expenses relating to the purchase of the property.
Expenses you can claim can be categorised into four types:
1. Borrowing costs
The interest repayments on your investment loan are tax deductible – this is often the most significant tax deduction you can claim. Note that if you take out finance for a renovation or improvement, interest on this loan is also claimable.
The ATO website states interest charges can be claimed on a loan used to:
- Buy a rental property
- Make repairs to the rental property – for example, roof repairs due to storm damage
- Fund renovations and extensions to a rental property
However, if you’ve used the property for personal use during the year, you cannot claim the interest incurred during that period. If you refinance and use part of the funds for personal use, such as to buy a car, that portion of the loan cannot be claimed.
Other borrowing costs you can typically claim include loan establishment and discharge fees, bank fees, lenders mortgage insurance and valuation fees.
2. Maintenance and repairs
The cost of repairs and maintenance you make to your investment property while it is being leased is usually immediately tax deductible. Note that a repair is classified as work that returns a damaged feature to its original state.
Examples of repairs include:
- Replacing a broken window
- Repairing electrical appliances
- Replacing part of a gutter damaged in a storm
- Replacing part of a fence damaged by a falling tree branch
Maintenance is work done to prevent deterioration or to fix existing deterioration.
Examples of maintenance include:
- Repainting faded or damaged interior walls
- Oiling a deck
- Cleaning a swimming pool
- Maintaining plumbing
‘Repairs’ that are considered capital in nature, or repairs of defects that existed when you bought the property, will likely need to be claimed as ‘improvements’ (more on this below).
Director of tax and communications at H&R Block, Mark Chapman, told Smartline he often sees investors making basic errors in this category, either accidentally or intentionally.
“Investors claiming repairs they’re not entitled to, so repairs that are actually improvements, they are capital in nature, nevertheless the investors are claiming them anyway,” Mr Chapman said.
“Or alternatively so-called ‘initial repairs’ which are actually repairs to defects which existed in the property when the property owner acquired it, they’re capital as well.
“That’s an area the ATO really does focus on, they’re very keen on checking repair deductions particularly larger ones.”
Expenses related to any improvements you make to your property – that is, changes that make the property better or more valuable – can usually be claimed, however, these types of expenses are not immediately deductible in full.
Instead, they need to be depreciated and claimed over their effective life. They are also subject to a number of rules, so be sure to clarify what you are entitled to with your accountant before you dive in.
Improvements can include:
- Capital works – e.g. a bathroom renovation
- Capital allowances – e.g. installing a dishwasher
- Initial repairs – e.g. fixing broken floorboards or cracks in a wall that existed at purchase
As with expenses for repairs and maintenance, the property must be genuinely available for rent for you to make a claim.
4. Other expenses
You can also claim an immediate deduction for other expenses related to your rental property.
This can include leasing costs, such as agent and advertising fees, as well as the costs of owning your rental property, such as council fees, body corporate fees (for properties on a strata title) and insurance.
Mr Chapman said the most important tip is for investors to keep good records.
“Keep records of your income, keep records of your expenses, invoices, receipts et cetera, and get a depreciation schedule,” he said.
“Basically if you’ve got all of those to hand then you can’t really go too far wrong.”
Can I claim stamp duty on tax?
No. You cannot claim the cost of stamp duty in your tax return as it is considered to be part of the cost of acquiring the property.
However, you can count this as a cost to reduce the tax payable on your capital gains if you later sell the property for a profit.
Can I claim loan repayments?
Yes and no. The interest paid on each loan repayment is tax-deductible however you can’t claim the repayments on your principal.
What happens if my deductions exceed income generated by my rental property?
If your expenses – that is, the cost of owning your rental property – are greater than the income the property generates (your rental income), it creates a taxable loss.
You can offset this loss against any other income you have, such as your salary, and reduce the tax you will pay. This is called negative gearing.
As always, be sure to speak with your accountant about the details as there are many rules around negative gearing. For example, your capital works deductions can’t exceed your construction expenses.
ATO priorities for 2022
While investment property tax deductions can be complicated, as an investor, it’s essential you are across the rules.
In May, the ATO announced it would be placing particular focus on rental property income and deductions when scrutinising tax returns this year.
ATO assistant commissioner Tim Loh said investors must satisfy three golden rules.
- You must have spent the money yourself and weren’t reimbursed.
- If the expense is for a mix of income producing and private use, you can only claim the portion that relates to producing income.
- You must have a record to prove it.
“If we do notice a discrepancy it may delay the processing of your refund as we may contact you or your registered tax agent to correct your return,” Mr Loh said.
“We can also ask for supporting documentation for any claim that you make after your notice of assessment issues.”
It’s prudent to starting getting organised well before you lodge your return so you have plenty of time to ascertain all your expenses.
You may even want to find an accountant who specialises in property investment – that way you can be sure you won’t miss out on claiming legitimate expenses, nor inadvertently claim expenses that aren’t allowed.
DISCLAIMER: The information contained in this article is correct at the time of publishing and is subject to change. It is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, Smartline recommends that you consider whether it is appropriate for your circumstances. Smartline recommends that you seek independent legal, financial, and taxation advice before acting on any information in this article.