Rental properties

The Australian Tax Office (ATO) has owners of rental properties in its sights as it moves to clamp down on property related tax deductions.

Owning a rental property has long been regarded as a tax-effective investment. Tax breaks like negative gearing and depreciation are particularly popular among property investors.

But the ATO has recently put property owners on notice, particularly those over-claiming expenses and incorrectly declaring capital gains on sale of the property.

Johanna Lowry, Senior Tax Consultant with the Institute of Chartered Accountants, offered the following advice and updates to help investors ensure they comply with the ATO’s rules.

Joint ownership

When two or more people own a rental property, tax law deems them to be in partnership. Most importantly, they share the net profit or net loss from the rental property in proportion to their legal interest.

For example, if two people own the property 50/50, they each claim 50% of rental income and related expenses – irrespective of who actually received the rent and who actually paid the expenses.

If the property is held by joint tenants (broadly, if one party dies the other automatically inherits their interest), the law generally deems them to own it 50/50, regardless of who contributed the funds to buy it.

Redraw mortgage facility

Investors who used a mortgage with a redraw facility to purchase the rental property, should think carefully before redrawing to fund private expenditure. Due to administrative complexities it may be more tax effective to ‘quarantine’ the private borrowings to quickly pay them off in full.

The holiday house

If you rent out your holiday house, the extent of your tax deductions depends on proving it is a viable commercial investment. If the property is genuinely held as an income-producing asset, your deductions relating to the property are apportioned according to the number of days in the year the property was available for rent, as a percentage of the total year. Any costs directly connected to the private use, such as cleaning, will not be deductible.

If the property is not really an investment – for example, the family uses it rent-free during peak holiday periods – there is a risk the ATO will allow a deduction for expenses only to the extent they offset the rent received; ie. you can’t make a net tax loss.

Repairs

Repairs are generally deductible if they relate to wear and tear or other damage caused while the property is rented or available for rent.

However, they will be non-deductible if capital or private in nature. For example:

If the repairs are so extensive as to amount to the replacement of the entire asset – for instance, replacing an entire fence – the expenditure will generally be capital
If the house has been used for private purposes and is subsequently rented out, repairs attributable to the private occupation won’t be deductible
Repairs that are needed at the time you buy the property are capital repairs and non-deductible, although can generally be added to the Capital Gains Tax (CGT) cost base of the property.
Depreciable assets or capital works?

Several recent ATO cases have highlighted the distinction between expenditure on depreciable assets and what is, in fact, part of the building or capital works. The primary issue is whether the items have a function separate from the building, or are an “integral part of the structure of the premises”.

Items including an in-ground swimming pool and spa, garage roller doors (excluding the power unit), outdoor TV antenna, built-in wardrobes, electrical cabling and a security system have all been found not to be depreciable.

Travel to inspect

You can claim a deduction for the cost of travel and accommodation incurred to inspect your rental property.

However, if there was also a private purpose to the trip – for example, to visit family members or a holiday – you can deduct only a portion of the cost. If inspecting the rental property was merely incidental, then the ATO maintains you only get a deduction for costs you can directly attribute to inspecting the property.

Body corporate fees

Body corporate fees are generally deductible. However, if a component is for a special-purpose sinking fund, rather than the general running of the complex, that component may well be capital and non-deductible.

CGT main residence exemption

If you are living in and renting out a property at different periods, bear in mind the restrictions surrounding the CGT main residence exemption. The fine print includes:

The exemption can only be claimed by individuals – not, for example, a family trust
Whether the property was your main residence, and over what period, is a question of fact
Provided it was your main residence to begin with, you can then move out and rent it for periods of up to six years However, you can’t claim the main residence exemption in respect of any other property during that time
If you rent it out first and move in at a later date, or move out of your main residence for a period of more than six years, you get a partial exemption. If part of the property was used for income-producing purposes – e.g. you rented out the granny flat – you only get the main residence exemption for a portion of the capital gain.
Profit-making schemes

Think carefully about how you undertake a major renovation or when constructing a new house on the property, if you then plan to sell it and make a profit. The ATO could view this as a profit-making scheme, and the full gain or profit will be taxable as normal income.

This overrides the CGT rules, therefore CGT exemptions – such as the 50% general exemption if you held it for more than 12 months, and the main residence exemption – won’t be relevant.

GST

Rental property owners are generally entitled to an ABN because they are carrying on an enterprise. However, the rent, being for an input taxed supply, does not count as turnover towards the GST registration threshold and therefore they would not be required to register for GST.

For more information contact your accountant, financial adviser or the Institute of Chartered Accountants.

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