The strategy To keep my nose clean when claiming my rental property expenses.
Why should I do that? Most investors are aware that the Tax Office has been taking a closer look at tax deductions claimed against investment properties in recent years. It has been concerned at the rate at which these claims are rising, and its reviews of investors' returns have shown mistakes are being made. On top of requiring property investors to fill out a separate tax schedule, it has been writing to taxpayers to outline its concerns.
But I'm entitled to claim those deductions, aren't I? You are entitled to claim a tax deduction for expenses incurred in earning assessable income. That's a basic tenet of our tax laws and holds true whether we're talking about income that you earn from working, or passive income earned on your investments. According to a recent Tax Office guide, you can claim two types of rental property expenses. The first are expenses such as council rates, insurance and interest on your investment loan that you pay in full each year. Like other deductible expenses, these can be claimed in the year that they are incurred.
The second type of deduction is for costs that are spread over a number of years. These include your borrowing costs, so-called capital works expenses (such as renovations and repairing problems that existed when you bought the property), and depreciation (the reduction in value of some items within the property). Depending on what the costs are, there is generally a schedule of the proportion of the cost that can be claimed each year.
But you can't claim tax deductions on properties that don't earn any income - such as vacant land - or on properties that are kept for your private use - such as holiday homes.
So what's the problem? The problem, according to the Tax Office, is that investors are making claims that they're not entitled to. Common mistakes include claiming the cost of the land as capital works (part of the cost of constructing or renovating the property) or claiming the cost of improvements (such as remodelling the kitchen or adding a deck or pergola) as repairs rather than capital works. In the first instance, the investor is making a claim they're not entitled to; in the second, they are claiming an immediate deduction whereas they should be spreading it over time.
What else are investors getting wrong? The Tax Office's list of common mistakes also includes people overclaiming deductions for the interest on their loans. Thanks to the growing popularity of home equity loans, it's easier than ever to use one loan for both investment and private purposes. But the Tax Office warns the interest on any private portion of your loan is not tax-deductible. And if you're thinking an investment property at Port Douglas sounds good, be warned the Tax Office is likely to take a close look at any travel expenses you claim. It says another common mistake made by investors is claiming the full cost of inspection visits to such properties, when the travel also served private purposes - such as a holiday.
Other common mistakes include claiming deductions on properties that are not genuinely available for rent and claiming full deductions on properties that are only available to rent for part of the year, such as a holiday home. If a holiday home is used free of charge by you, your family, or your friends for part of the year, the Tax Office says you aren't entitled to claim any costs incurred during those times.
Depreciation and capital works are also sticky areas where investors are prone to making mistakes. In response, the Tax Office's latest Rental Properties booklet includes a list of more than 230 items used in residential investment properties and how they should be treated.