Being aware of the tax deductions available for your investment property can significantly increase your tax refund. Unfortunately, many investors fail to take advantage of these deductions due to a lack of information provided by the Australian Tax Office (ATO). Understanding all the tax benefits available to you can be the key to achieving positive cash flow from your investment property, rather than just striving to earn enough money. Here are some top tax tips that will keep your money where it belongs – in your hip pocket.
Tax Deductions on Borrowing Costs and Loan Interest
One of the most significant tax deductions you can claim as an investor is the interest payments on your investment loan. This includes loans taken out for renovations or improvements on the property. According to the Australian Tax Office (ATO), interest charges can be claimed on loans used to purchase a rental property, make repairs, or fund renovations and extensions.
Pro Tax Tip: If the property is used for personal use during the year, the interest incurred during that period cannot be claimed.
If funds from refinancing are used for personal use, such as buying a car, that portion of the loan is not eligible for a deduction. Other borrowing costs that can typically be claimed include loan establishment and discharge fees, bank fees, lenders mortgage insurance, and valuation fees. These fees will usually be claimed over a 5 year period.
Tax Deductions on Maintenance and Repairs
The expenses associated with repairs and maintenance for your investment property while it is being leased are typically tax deductible. A repair is defined as work that restores a damaged feature to its original condition. Examples of repairs include replacing broken glass, repairing electrical appliances, replacing a damaged part of a gutter or fence.
Maintenance, on the other hand, is work done to prevent deterioration or to fix existing deterioration. Examples of maintenance include repainting faded or damaged walls, oiling a deck, cleaning a swimming pool, and maintaining plumbing.
However, it is important to note that 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 and claimed over a number of years. This is an area that the ATO focuses on and is known to scrutinize, particularly for larger repair deductions.
Tax Deductions on Improvements
Expenses related to any improvements made to your property, or changes that increase its value or usefulness, can typically be claimed, however, these types of expenses are not immediately deductible in full. They must be depreciated and claimed over their useful life and are subject to various rules. It’s important to clarify what you are entitled to with your accountant before proceeding.
Examples of improvements include capital works such as bathroom renovation, capital allowances like installing a dishwasher and initial repairs such as fixing broken floorboards or cracks in the wall that existed at the time of purchase. Improvements that form part of the home such as replacing a roof, adding rooms or replacing an entire fence will be subject to a deduction over a 40 year period. Assets such as appliances like cooktops, ovens or a hot water system will typically be claimed over a substantially smaller period of time based on their effective life.
Pro Tax Tip: The property must be genuinely available for rent for you to make a claim.
Tax Deductions on Stamp Duty
The cost of stamp duty is not tax deductible as it is considered a cost of acquiring the property. However, it can be used to reduce the tax payable on any capital gains made when the property is sold for a profit in the future.
What if your expenses are higher than your rental income?
If the expenses of owning a rental property, such as mortgage interest, repairs, and maintenance, exceed the income generated by the property, it results in a taxable loss. This loss can be used to offset any other income, such as salary, thus reducing the overall tax liability. This is known as negative gearing. It’s important to consult with an accountant for detailed guidance as there are various rules that apply to negative gearing. For instance, the deductions for capital works cannot exceed the construction expenses.
Taxes and Rates
When it comes to property investments, you can claim deductions for various expenses related to the property. These include:
- Water rates, charges and usage
- Council rates
- Land tax (first-time owners are required to file an initial land tax return with the Office of State Revenue in their respective state or territory)
Claiming the right amount of expenses
Properly allocating expenses is crucial when it comes to tax deductions for rental properties. If any of the following apply: the property is only available for rent for part of the year, the property is used for personal purposes for part of the year, only part of the property is used to earn rent, the property is rented at non-commercial rates, or the investment loan is partially used for personal purposes, you will need to determine the portion of the expense that relates to income-producing activities.
You may need to distinguish which expenses are private in nature. For example, if only a part of the property is rented out, expenses should be calculated on a floor-area basis based on the area occupied by the tenant and a reasonable amount for access to common areas. However, other expenses such as advertising for tenants and real estate commission that solely relate to renting out the property are fully deductible.
Selling your investment property
When selling an investment property or main residence that you have rented out, it’s important to keep in mind a few key points regarding tax implications:
- You may be subject to capital gains tax, even if you transfer the property to someone else.
- A capital gain is calculated as the difference between the cost of ownership (cost base) and the capital proceeds (the amount received from the sale or the market value when the property is transferred).
- If the costs of ownership exceed the capital proceeds, a capital loss should be reported and may be used to offset future capital gains.
- If deductions for capital works or depreciation were claimed in previous years, these amounts should not be included in the cost base.
- If the property was owned for 12 months or more and you are an Australian resident, you may be eligible for a 50% discount on tax on the capital gain.
- It’s always recommended to consult with an accountant to ensure the proper calculation and reporting of capital gains tax.
Being aware of the tax deductions available to property investors can greatly increase the potential for positive cash flow and financial success. Navigating the rules and regulations associated with these deductions can be complex and time-consuming. From claiming interest payments on investment loans to depreciating the cost of improvements, it is essential to have a clear understanding of what deductions are available and how to claim them correctly. A tax agent has the knowledge and expertise to help you identify the deductions that apply to your specific situation and to ensure that your claims are accurate and comply with the regulations. They can also provide valuable advice and guidance on negative gearing, capital gains tax and other tax-related matters.