The Australian Taxation Office (ATO) has found that nine out of ten residential rental property investors audited have made errors in their tax returns. Here are some common tax traps and pitfalls to be aware of:
Apportionment of Rental Income and Deductions
If a rental property is jointly owned, the income and deductions must be divided according to each owner’s share. For example, if spouses own the property together, it’s typically a 50:50 split. The spouse with the higher income cannot claim more than their share of the deductions, even if they paid for expenses from their own account.
Private Use
You can’t claim deductions for interest and other expenses for periods when the property was used for private purposes, like if you or a relative lived in it for no or nominal consideration.
Interest Deductions
Interest on loans used to buy a rental property is deductible. However, if the loan is used partly for personal expenses (like buying a car), only the portion related to the rental property can be claimed. Be careful when refinancing to ensure the interest remains deductible.
The cost of genuine repairs to fix something that is broken or worn down due to wear and tear that happened while the property was tenanted is immediately deductible. Work that involves replacing the entirety of an asset would be a capital improvement and is deductible at 2½ %.
For example, your rental property might have an original 1960s bathroom, with leaky pipes and tiles that are broken or coming away. Fixing the leaks and replacing the tiles (even with something a little more modern) would fall on the repairs side of the line and be deductible outright. On the other hand, gutting the whole bathroom and replacing all the fittings with something out of Home Beautiful would be a capital upgrade and deductible at 2½ % per annum.
Initial repairs
Any deductions for repairs to your rental property have to be attributable to the time you were earning rental income from the property. If you buy a property that requires initial repairs before you can put tenants in, the cost of those repairs will not be deductible. You should still keep track of the amount you’ve spent on initial repairs as it will trigger off a capital loss when you sell the property down the track.
Certain initial repair works may be unavoidable, but defer non-urgent work if possible. So if your newly acquired rental property is in need of a coat of paint, maybe wait two or three years before contacting a painter.
Travel costs
The cost of traveling to visit your rental property to attend to things is no longer deductible. This matters especially to investors who have bought property interstate. There is an exception where an investor is in the business of letting rental properties – but very few are.
Depreciation
Second-hand depreciating assets acquired as part of the rental property can’t be written off against rental income, again unless you are in the business of letting rental properties. But the unclaimed depreciation can trigger off a capital loss on the eventual sale of the property. It’s important to keep track of these amounts in the meantime.
Cash jobs
It’s not unheard of for the tradesperson offering the best quote for a repair or maintenance job on your rental property to ask for payment in cash. Before rushing in to accept such a quote, just make sure they’re not keeping the job completely off the books and that you’ll still be getting an invoice that satisfies the substantiation rules. Otherwise you could end up blowing your cost savings (and maybe more) because you won’t be entitled to a tax deduction for the cash you’ve handed over.
What your tradie does in relation to his tax affairs is a matter between them and the Commissioner, but it shouldn’t cost you a tax deduction. Always insist on getting an invoice.
Holiday homes
Own a holiday home? Great for family holidays, but if the property is also offered for short-term rentals there are a few wrinkles you need to be aware of.
The main one is that the property needs to be genuinely available for rent, and not just at times when demand is seasonally low. So if you book the place out for yourself or family and friends for all or most of the school holidays and other peak times, the ATO will take the view that you’re not seriously trying to make a profit from any rental income you receive and will limit your deductions for mortgage interest, rates and land taxes, repairs and maintenance, insurance etc to the amount of your rental income. Likewise if you only charge mates’ rates when family and friends come to stay.
Some holiday house owners have even pretended to market their property by demanding excessive rents or imposing unrealistic conditions for short-term stays (eg. references, no pets, no kids). That is not likely to pass muster either.
Some limited personal use of the property is acceptable to the ATO, as long as you’re genuinely trying to turn a profit. Where this is the case, the deductions claimed need to be pro-rated to reflect the time the property was let or was genuinely available for rent.
Any disallowed deductions won’t be wasted entirely as they will create a capital loss on the sale of the property.
Being aware of these traps can help you manage your rental property effectively and ensure you stay compliant with tax regulations.