Owning a rental property is a great long-term investment. Your property will increase in value over the years, and you’ll earn a passive income from the rent you charge. For these reasons, rental properties are considered income-earning businesses in the eyes of the Australian Taxation Office (ATO). So any money you earn from your rentals will have tax implications.
The ATO also classifies rental properties as investments, meaning there are a range of tax deductions savvy homeowners can claim. Read on to make sure you’re taking advantage of all the rental property tax deductions you’re entitled to.
What Type of Rental Income Are You Earning?
Before we get into the tax deductions, it’s important to clarify what type of rental income you’re earning. The ATO has three separate classifications for the ways in which rental income is generated:
- Residential lease or short-term holiday rent
- Utility, water usage, and property damage reimbursements
- Loss of rent insurance payouts
All of these forms of income are taxable, but each has different tax consequences.
Pro Tax Tip: Expenses, rental income, and tax should be proportioned between partnerships and property co-owners. If you’re not sure how to go about this, contact ITP today. One of our skilled accountants can help you optimise your rental income and expenses for tax purposes.
Rental Expenses You May Be Able to Claim on Your Tax Return
There are five main categories of rental expenses you need to know about. These are:
- Property ownership
- Property management
- Loan interest
- Capital works
This category includes expenses incurred as a part of owning a property. Some examples include:
- Council and local government rates
- Land tax and body corporate fees
- Insurance costs (building, contents, public liability, loss of rent)
- Water and sewerage rates, levies and charges
Note that you can only claim these and other ownership expenses if you incurred them. You cannot claim anything your tenant paid for on your taxes.
There are four types of expenses you might incur through managing your property:
- Advertising and marketing: If you have a rental, you’ll likely have to invest in advertising to find tenants. You can generally claim costs associated with advertising, property management, rent collection and inspection, lease preparation, fire protection inspections, pest control, eviction, and cleaning in the same year you incurred them.
- Repairs and maintenance: Your rental property will experience wear and tear. Thankfully, you can usually claim back the costs of things like repairing roof tiles after a storm or an appliance that’s stopped working. Once again, you need to make your claims in the same year as you incurred the costs. Under repairs and maintenance, you can also claim for replaced appliances and depreciation of other capital items you’ve purchased for your property. To be deductible, the repairs must be directly connected to the rental activity and not something caused by a previous owner of the property. Repairs necessitated by a natural disaster still fit within the repair and maintenance expense category.
- Managing your taxes and financial affairs: You can claim the fees you pay to your tax agent, financial advisor, property manager, and bookkeeper. You can also claim fees or commissions paid to agents who collect rent, find tenants, and maintain your rental. As always, you must submit your claim in the same year as you incurred the expense.
- Property management education: If you’ve undertaken study or attended seminars to understand the rental market and maximise the properties you own, you’ll be pleased to know that you may be able to claim these costs. Just note that you can’t claim any educational expenses incurred before you purchase your rental property.
If you’ve taken out a loan to pay for your rental property, you can claim a tax deduction for the interest on the loan. However, it’s vital that your property is genuinely rented for the income year in which you’re claiming the loan interest.
Pro Tax Tip: The principal amount is the money you borrowed from your bank or lender. You can’t claim this as a tax deduction.
You can claim tax deductions on the interest paid on loans used for:
- Rental property purchase
- Purchase of a depreciating asset
- Rental property repairs after a disaster or accident
- Renovations on the rental property
- The costs of obtaining the loan
Pro Tax Tip: You can claim pre-paid interest up to 12 months in advance.
There are circumstances where you won’t be able to claim interest. These include:
- Times when you’re using the property privately
- Any portion of the loan used for private use
- Part of the loan used to purchase a new home that’s not producing income
- Funds used to buy vacant land until the time of construction
- Funds used form the loan to purchase items for another purpose
Flooring, appliances, window coverings and other capital items in a rental have an effective life span for taxation purposes. You must adhere to these rules when it comes time to claim a tax deduction. The ATO determines the depreciation period for capital items, which can be either 5 or 20 years.
Some capital items include the costs of construction or the building as well as structural improvements and extensions.
Pro Tax Tip: If you’ve replaced a worn-out or broken part of a capital item, the ATO will likely classify this as a repair. That means you can usually claim such expenses as repair and maintenance costs. If you replace an entire structure or damaged asset, the ATO will likely see it as a capital cost that will need to be depreciated.
Capital works are construction expenses used to produce income. The rate of deduction for these expenses is generally 2.5% per year for 40 years following construction. Capital works include:
- Construction costs
- The cost of altering a building
- Major renovations to a room
- Adding a fence
- Building extensions such as garages or patios
- Adding structural improvements like a driveway or retaining wall.
The ATO classifies improvements as anything that changes the character of your property and/or makes your property more valuable or desirable. Such changes to the property are classified as capital works if they are structural in nature.
Some other examples of improvements include:
- Adding a gazebo, carport, or other new feature to the property
- Anything that improves the income-generating aspect of renting the property or extends the life of the property
- Anything that goes beyond restoring the original design or feature of the property
Need Help Claiming Your Rental Property Tax Deductions?
Claiming tax deductions for rental properties can be complex. It’s also vital to note that this report is general in nature and doesn’t take into consideration many factors unique to your situation. For this reason, we always recommend seeking the advice of a professional tax agent. This is the best way to ensure you maximise your rental property tax deductions while remaining 100% compliant with Australian tax laws. For expert advice tailored to suit your specific circumstances, make an appointment with your nearest ITP branch today.