The ATO has identified that the most common reason for tax return amendments relate to incorrect claims that are made on rental properties. Over 2 million Australians own one or more investment properties.
There are many common misconceptions when it comes to rental investment properties and what tax deductions can be made when you own an investment property. The tax update that was implemented on the 1 July 2017, may be directly linked to the high percentage tax return amendments relating to incorrect claims on rental properties. It’s important to remember that we can only claim rental deductions on costs that are directly associated with producing the rental income excluding second hand assets.
Rental Property Misconceptions
Some common misconceptions include deductibility of mortgage repayments, access to depreciation rules such as small business depreciation, temporary full expensing, deductibility of second-hand assets and travel costs.
Mortgage Payments
Mortgage payments are not tax deductible on rental investment properties, it is only the interest component of the mortgage that is tax deductible. This is often an area of confusion particularly when terms such as negative gearing are mentioned. A rental property is not a small business and is therefore not entitled to small business depreciation and temporary full expensing rules.
Depreciating Assets
Historically second-hand assets were treated as a depreciating asset and the depreciation was tax deductible, however from 1 July 2017 that has changed, clients can’t claim the decline in value of second-hand depreciating assets, except for second-hand assets that are purchased for rental properties that are used for carrying on a business. This change also does not apply to properties that were rented out prior to this date. Furthermore, the travel costs inspect rental properties may have been deductible in years gone by, however this is no longer the case.
Interest deductions
A common error made in terms of residential rental property deductions is accounting for the deductibility of interest on people’s mortgages. It’s quite common for many to drawdown on their mortgages for their personal expenses (personal expenses may include renovations to your main residence, a new car, funding for a holiday etc.). The blunder can be made when people fail to adjust the interest deduction on their loans to reflect these personal drawdowns when completing their tax returns. When it comes to drawdowns on mortgage arrangements for personal expenses, the interest component on the personal drawdown needs to be distributed based on the amount of the drawdown relative to the loan. The allocated amount is not tax deductible and needs to be adjusted out when completing the tax return.
Depreciation deductions
Depreciation on assets that relate to residential rental properties is also a common misconception and mistakes can be made. It can be particularly confusing with a lot of media attention on small business depreciation rules and temporary full expensing encouraging people to buy up big on assets to stimulate the economy.
The rules are not applicable to residential rental properties as residential rental properties are not carrying on a business and therefore do not meet the requirements for access to these depreciation rules that are available for businesses. The immediate deduction threshold for assets that relate to residential rental properties is $300, assets over this amount will need to be assessed and subject to depreciation on an effective life basis. The effective life can be an ATO determined effective life which can be found on the ATO website or a self-assessed effective life.
If you self-assess the effective life of an assets, it is important to maintain good records of how you determined the effective life. In terms of what assets rental properties can claim as depreciation, the rules were updated from 1 July 2017, there are several requirements which are:
- The asset purchased must be brand new
- It is a newly built property, and no prior depreciation has been claimed on that asset
Division 40 vs Division 43
Another area that may cause some confusion, is the difference between division 40 deprecation on plant and equipment and Division 43 capital works allowance or building write off.
Division 40
Division 40 relates to removable fixtures and fittings within an investment property. Each item is treated separately on a depreciation schedule, with a different effective life as mentioned above. Division 40 often includes ovens, hot water system, carpet, blinds etc.
Division 43
Division 43 capital works allowance covers structural elements of a building and items within the rental property that are irremovable. This may include things such as foundations, walls, ceiling, toilets, built in cupboards, windows, doors etc. Division 43 capital works allowance can be claimed at a rate of 2.5% over 40 years or 4% of a properties historical construction costs or estimated costs that can be claimed. The estimated costs are assessed by professionals such as a quantity surveyor. Many clients choose to engage a quantity surveyor to assess their residential rental property and prepare rental depreciation schedules that outline the appropriate tax deductions on a yearly basis.
Ultimately, both the Division 43 capital works allowance and Division 40 depreciation on plant and equipment will impact the cost base of the rental property when the rental property is sold. The amount of depreciation that has been claimed on the tax returns over the time of owning the rental property will reduce the cost base of the rental property. The depreciation and capital works allowance claimed will be added together and subtracted the cost base of the rental property. This will add to the capital gain when the rental property is eventually disposed of.
The key distinguishing factors between Division 40 and Division 43, is that Division 40 assets depreciate faster and consist of removable assets to the property. While, in comparison Division 43 assets are depreciated slower and are irremovable from the property.
Repairs and maintenance or capital expenditure
Determining if some costs are considered depreciable assets and depreciated over the effective life of the asset or if costs can be considered repairs and maintenance and deducted in full isn’t always clear.
Costs considered repairs and maintenance should have direct correlation with wear and tear or other damage that has occurred because of renting out your property. Rental repairs are often carried out when the property continues to be rented on an ongoing basis or the property remains available for rent. There is a short period when the property is unoccupied, for example, where unseasonable weather causes cancellations of bookings or advertising is unsuccessful in attracting tenants.
Summing up
When preparing a tax return regarding your rental property, there are many mistakes that can made due to the public misperceptions. It’s important to employ an accounting professional to ensure you’re complying with the most up to date regulations.
The Oracle accounting team can actively assist you with these common rental property misconceptions to claim the correct deductions on your tax return and ultimately give you the most tax effective outcome. Our advice will also allow you to make informed decisions when it comes to any upcoming expenditure on your rental property.
Get in touch with us today and book an appointment with an Oracle Accountant, to ensure you receive the most effective tax return.
Written by Jeremy Lee
Senior Accountant
Oracle Accounting Charlestown
Important information – Oracle Advisory Group makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation or needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek their own professional advice. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.
