You may have read in the financial pages of your weekend newspaper recently with the ATO confirming rental property investors will be firmly in their sights when submitting their 2019 tax returns.
Based on recently performed random sampling the ATO has found 9 out of 10 income tax returns contain errors relating to non-compliance with property investing.
Billions of dollars in deductions are claimed each year by property investors. With such a large value being claimed, the government can save significant taxpayer funds if the annual value of these claims can be reduced. As a result the ATO will double the number of property related tax audits in the 2019 year.
The ATO’s key areas of concern include:
Repairs – Maintenance or Capital Improvement?
In summary, a claimable repair should only bring the asset back to the same condition it was in when you first acquired the property.
Expenditure should be treated as a capital improvement if the asset is improved beyond its original condition.
A repair is claimed upfront, however a capital improvement is subject to depreciation rules and generally claimed over the term of its useful life.
Another potential trap is expenditure for repairs which are incurred at the time of purchase prior to when the property is available for rent. This expenditure in most cases should be treated as improvements.
The deductibility of loan interest is generally based on the answer to the question – what were the borrowed funds used for?
It is extremely important for loans to be structured correctly to ensure full interest deductibility. If a loan has a mixed purpose (eg the loan proceeds were used partly for private purposes), then this will reduce and sometimes eliminate the ability to claim interest costs. Loans with redraw facilities where the redraw is used for a private purpose will also reduce interest deductibility.
If you wish to periodically deposit funds into a loan and have the ability to redraw these amounts for a private use, then an “Offset Account” is a much better option. This will reduce the loan interest you pay, but at the same time give you a greater chance of maintaining maximum tax deductibility.
When an investment property is sold, capital gains tax needs to be calculated on the disposal to determine if a profit has been made.
If the investment property has been held for a period of greater than 12 months, a 50% discount on the profit is usually allowed. One item which is generally overlooked is the requirement to add back capital works depreciation claims (depending on the date of acquisition and date of construction of the property) to the profit calculated. This will result in a higher profit for capital gains tax purposes.
Non-resident taxpayers will also be subject to different rules relating to eligibility to access the 50% discount.
Personal Expenses and Holiday Homes
The ATO has a major concern in this area.
If you are using your holiday home for private use then you need to ensure expenses are apportioned correctly. Eg, if the property is available for rent for only 60% of the time during the year, then claimable holding costs such as utilities, insurances, interest, etc will reduce accordingly.
Also, if these properties are rented out at non arms-length rates to friends and family (eg at a discount), this will further reduce your ability to claim expenses to their full extent.
Partly Renting Your Home
If you are renting a room in your home and/or making it available for purposes such as AirBnB you must report this income to the ATO. You must also ensure any expenses you claim are apportioned correctly and take into account any private use element.
Partly renting your home will also reduce your ability to claim the CGT Main Residence exemption upon the eventual sale of your home.
The ATO’s approach is the onus of proof of deductibility is on the taxpayer.
Without a valid basis for the deduction claim and/or without evidence of the expenses incurred, the ATO will simply deny the claim.
Depending on the circumstances and how blatant the errors in the deduction claim are, the ATO will also generally apply penalties of 25% to 75% of the extra tax liability plus interest.
In other words, get the right tax advice.
Claim what you can legitimately claim.
Don’t try and be too clever!