Managing your rental property investments involves more than just collecting rent. To ensure you’re getting the most out of your endeavours while staying compliant with tax regulations, it’s crucial to understand the nuances of rental property tax deductions. As your trusted accounting firm, we’re here to provide you with essential tax tips for your rental property ventures.
Initial Repairs and Capital Improvements:
When addressing repairs or improvements, it’s vital to distinguish between repairs and maintenance expenses, long-term capital improvements, or initial repairs.
Initial repairs for pre-existing damage upon property purchase are not deductible, even if not immediately addressed. This includes tasks like replacing broken cupboard doors or fixing damaged floorboards, however you may be able deduct these expenses over several years as capital works deductions. Regardless, it is important to keep a record of these expenses as they will likely need to be added to the cost base of the property when it is sold, lowering your potential capital gains tax obligations.
Capital improvements made to the property, such as upgrading the entire roof or remodelling a bathroom, are not considered repairs or maintenance making them not immediately deductible. Instead, these expenses can be claimed as a deduction under capital works depreciation at a rate of 2.5% annually for 40 years. The unclaimed portion of these expenses at the time of sale will also be added to the cost base of the property, lowering any capital gains tax obligations.
The replacement of damaged depreciating assets costing over $300, are another form of non-immediate deduction. This deduction is the most commonly miss classified form of deduction by a property investor, as what often starts as a repair quickly turns into a replacement.
For example, your rental properties air conditioner has stopped working in the peak of summer. To correct this the real estate agent arranges to have a service man come look at the issue. Luckly, he was able to repair the AC by replacing a part and invoices you for $400. This expense would be deductible against the rental income in full that financial year as a rental expense.
However, if the service man deems that the air conditioner is not worth repairing and the decision is made to order and install a replacement. His invoice, now $1,200 and would be considered a replacement. Therefore, the ‘new’ depreciating asset would need to be deducted as an expense over the deemed life of the air conditioner.
Body Corporate Fees and Charges:
Closely linked to the idea of deductible expenses and capital improvements is the consideration of your properties body corporate expenses. The same rules apply for properties under body corporate as those imposed on freehold properties. This means that charges relating to standard repair and contributions to a sinking fund are fully deductible in the year they are incurred. However, major capital replacements and improvements will need to be depreciated as a capital works deduction at a rate of 2.5% annually for 40 years. Typically, capital improvements carried out by body corporate are easily identifiable and invoiced on a separate statement when the improvements are scheduled to commence.
Claiming Interest on Loans:
In the high interest rate environment that we have all been faced with in recent years, investors with outstanding loans will have seen an increase in the interest related tax deduction associated with their investments. This increase underscores the importance of understanding which portion of your loan’s interest is deductible and which are not. The interest paid on any principal amount borrowed for the initial purchase of the property or capital improvement (like renovations) is deductible and can be claimed against the rental property’s income for the life of the loan.
However, not all interest is deductible. If at any point a line of credit is established for purposes other than the initial purchase or improvement of the property, the interest charged on that portion of fund will not be deductible. This includes the use of redraw facilities and all other refinancing activities that use the investment property as security.
For example, if Steve wants to paint his rental property and decides to redraw the amount required from the properties redraw facility; the full amount of interest charged on the investment property loan moving forward would remain tax deductible.
However, if Steve wants to go on a holiday and decides to redraw the amount required from the properties redraw facility; the interest charge on the loan moving forward would need to be apportioned to remove the % of interest that is effectively being charge on money used for the holiday.
Additionally, the ATO has ruled that all repayment made after the redraw has taken place must be allocated using the same percentage method; meaning you cannot simply repay an amount previously redrawn for personal use and restore the loan to 100% investment related. For more information on the ATO’s ruling click here.
Record keeping requirements:
A sometimes-overlooked process of owning an investment property is the record keeping requirements. However, the process forms the foundation of any deduction as you must have evidence of your rental property income and expenses to claim a deduction.
Furthermore, evidence is also required to claim an expense as part of your properties cost base when it comes time to calculate capital gains tax (CGT) for the sale of your rental property. Therefore, we recommend keeping all records for the entire period you own a rental property, and for 5 years from the date you sell it.
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