ATO Warns Property Investors – What you need to know

ATO’s Focus on Property Investors

One of the major areas of focus for the ATO is on investors who are claiming deductions that they are not entitled to. The ATO is keen to stamp out the practice of “double-dipping” where owners deduct expenses already covered by the property manager.

Another common issue is where investment property owners are redrawing or refinancing a loan for their rental property and using the money to pay for private expenses. Whether it’s buying a new car or going on a holiday, the interest on these types of personal loans is not tax-deductible.

For example, if you have a $800,000 mortgage for a rental property and then add $80,000 to the loan to purchase a new car, you can only claim the interest on the initial $800,000, not the interest on $880,000.

The ATO uses data matching to identify these claims and will take action against those found to be incorrectly claiming deductions.

Common Tax Strategies Targeted by ATO

In addition to cracking down on incorrect deductions, the ATO is also targeting common tax strategies used by property investors. These include:

• Claiming repairs and maintenance as immediate deductions: Some repairs and maintenance can be deducted, but they need to be categorised as either “improvement” or “repair”. Improvements are not immediately deductible and must be depreciated over time. For instance, fixing a broken fridge is a repair and can be claimed immediately, but installing a new kitchen would be considered an improvement. In this last instance, the cost must be deducted over several years.
• Incorrectly claiming expenses: Expenses related to borrowing, such as loan establishment fees and lender’s mortgage insurance, are often claimed incorrectly. These expenses are generally deductible over a period of five years.

Rental Property Deductions

The ATO warns rental property owners to avoid common errors like overclaiming deductions, mixing personal and rental expenses, and misclassifying repairs and capital works.

Repairs, renovations, and rent:

As a rental property owner, you can claim immediate deductions for repair and maintenance costs. However, significant renovations or improvements that increase the property’s value must be deducted over time as capital works expenses. If you use the property for both personal and rental purposes, you cannot claim deductions for periods of personal use, including when family or friends stay rent-free.

Common tax deductions for rental properties:

• Advertising for tenants
• Body corporate fees and charges
• Council rates and land taxes
• Insurance premiums
• Interest on loans to purchase the property or for renovations
• Property management fees
• Repairs, maintenance, and pest control expenses
• Legal expenses related to renting out the property

It’s important to keep detailed records of all expenses related to your rental property as they are required by the ATO in case of an audit. Not providing proper documentation or w”double-dipping” on claims can result in penalties and interest charges.

Depreciation Claims

One of the major reasons to invest in a new rental property is the ability to claim depreciation expenses. Whether it’s for the building itself, furniture, or appliances provided for tenants’ use, depreciation can help reduce your taxable income. The ATO allows two methods of claiming depreciation:

Prime Cost Method:

This method assumes that each asset will have a specific lifespan and depreciate evenly over that time. This method is most beneficial for assets with a long-life span.

Diminishing Value Method:

This method assumes that an asset will lose more value in the earlier years and less as it ages. This method is best suited for assets with a shorter effective life.

Common property can also be depreciated, such as shared lighting and carpets in common areas. These items typically fall under the category of “capital works” depreciation. For example, the ATO allows property investors to claim a deduction on capital works for assets like shared lighting and carpets at a rate of 2.5% per year over a 40-year period. This means that if the cost to install shared lighting and carpets in the common areas was $20,000, you could claim a deduction of $500 each year for 40 years.

Filing Associated Income & Work-Related Expenses

It is important to properly report all rent payments received from tenants, as well as any additional income from services provided, such as laundry or parking fees.

It is also important to accurately record and claim work-related expenses that may arise from managing your rental property. These can include travel expenses for conducting inspections or attending meetings with property managers, costs for advertising the property, and fees paid to contractors for maintenance and repairs.

If you fail to report this income, you may be subject to penalties and interest from the ATO.

Personal Expenses

The ATO is particularly concerned about how income and expenses related to rental properties are reported.  It is important to keep personal expenses separate from rental property expenses, as these cannot be claimed as deductions. This includes using the rental property for personal use or claiming expenses that are not directly related to managing the property, such as personal phone bills or general household expenses.

For married couples, sharing the ownership of rental properties can offer several tax benefits. Couples can split rental income and expenses, potentially lowering their overall tax liability by taking advantage of lower individual tax brackets. However, the ATO warns against manipulating income splits to unfairly reduce tax. Both partners must genuinely share in the ownership and control of the property and income.

Summary

Proper tax reporting for rental properties is the key to avoiding penalties whilst maximising the financial benefits of property investment.

Knowing which deductions you can claim and which expenses to keep separate is essential in accurately reporting rental income to the ATO.

It is important to ensure that personal and rental property expenses are kept separate, and to consult with an accountant or tax professional for guidance on any complex tax matters. Remember, the ATO closely monitors rental property income and expenses, so it is important to report all income and expenses accurately. Failure to do so can result in penalties and interest charges, which can significantly impact your overall return on investment.

At Ironfish, our mission has always been to help property investors find the right investment property that can generate long-term wealth. Our professional property management services ensure a stress-free experience for our clients, with expert guidance on navigating tax matters related to rental properties. We can help you make the most out of your property investment by taking a proactive approach towards tax planning for your rental properties and enjoy the rewards that come with successful property investing.