Top tips for landlords under the ATO's microscope

Australian landlords’ tax returns are likely to be closely scrutinised in 2020, as the tax office tries to close an $8.7 billion gap between the tax it expects individuals to pay and what is actually paid. 

The ATO recently said it believed mistakes in rental property claims made up the second-biggest component of that tax shortfall, following work-related expense claims.

Aus Property Professionals director Lloyd Edge said the ATO’s focus on property highlighted the complexities of tax returns for landlords, with mistakes commonly made as investors navigated their way through the wide range of deductibles, depreciation and tax benefits available.

Deductions expected to come under close scrutiny this year include excessive interest expenses, where property owners have attempted to claim the costs of finance for their residence as well as their rental property, while jointly-owned rental incomes will also come under the microscope.

Holiday homes will also be closely watched, with the ATO to ensure deductions are solely for expenses involved when the property is genuinely rented out or available to rent.

Mr Edge said it was also crucial that investors were across several key changes that will impact their returns in 2021.

“Firstly, the government brought forward stage two of the Personal Income Tax Plan, meaning people will have more disposable income, which will help drive house price growth,” Mr Edge said.

“Additionally, the low income tax offset has increased, which will put more money into people’s pockets and the temporary tax relief for merging super funds is now permanent, giving people less control.”

Mr Edge shared five areas he believed should be the main tax consideration for investors in 2021.

1) Is your investment property jointly owned with 2 or more owners? If so, the rental income and expenses from the property must be divided among the co-owners according to their legal interest in the property. This is despite any written or oral agreement between the co-owners stating otherwise, for example, even if you’ve agreed that one owner can claim 100 per cent for tax purposes, you cannot do this. 

2) Ensure you keep records from the very beginning. If you invest in a rental property or rent it out, you’ll need to keep records right from the start so you can work out what expenses you can claim as deductions and ensure you declare all your rental-related income in your tax return. Proof of expenses can be in the form of receipts, bank statements, or credit card statements. You will also need the records of the date and costs of buying the property so you can work any capital gain (or loss) when you dispose of it. 

3) Declare all rental related income. Alongside the full amount of rent, you must also include rental bond money you become entitled to retain e.g. when a tenant defaults on rent or you incur maintenance costs, insurance payouts in some circumstances, letting and booking fees you receive, associated payments you receive as a part of the normal, repetitive and recurrent activities through which you intend to generate profit from the use of your rental property and reimbursement or recoupment for deductible expenditure. It’s important to note that GST doesn’t apply to rent on residential premises – you’re not liable for GST on the rent you charge. 

4) To claim deductions for expenses, your property must include a dwelling that is rented or available for rent.

There are many expenses you can claim, including: 

• Repairs and maintenance e.g. replacing electrical appliances or painting a rental property.
• Interest expenses e.g. the interest charged on the loan you used to purchase a rental property or a depreciating asset (an air conditioner). However, you can’t claim interest on the portion of the loan you use for private purposes or on a loan you used to buy a new home if it doesn’t produce income.
• Legal expenses e.g. evicting a non-paying tenant or defending a damages claim. However, you can’t claim on items like solicitor’s fees for the purchase of the property or preparation of loan documents.
• Borrowing expenses e.g., loan establishment fees, title search fees and cost of preparing and filing mortgage documents. However, you cannot claim on the loan balances for the property or stamp duty charged on the transfer of the property title.
• Depreciating assets – depreciation is the amount an asset declines in value over time, so for an investment property it is based on its ‘useful life’ or the number of years a property is expected to be in use. Some items include carpet, ovens, cooktops, dishwashers, heaters, blinds and curtains. It doesn’t matter if the depreciating asset installed was new or used, or if the property was new or not.

5) You need to navigate Capital Gains Tax when you sell your investment property.

A capital gain, or loss, is the difference between what it cost you to obtain and improve the property (the cost base), and what you receive when you dispose of it. Amounts that you’ve claimed as a tax deduction, or that you can claim, are excluded from the property’s cost base. Even if you have an investment property that isn’t rented out e.g. a holiday home, the property is subject to CGT in the same way as a rental property.

One step to maximise returns

For those looking to get the most out of their returns, BMT Tax Depreciation chief executive Bradley Beer said there was a simple step that investors could take to ensure what their returns were as high as possible.

Mr Beer said investors who paid expenses such as loan interest, levies, insurance or tax depreciation schedules in advance could significantly reduce the amount of tax they pay.

Of those prepaid expenses, Mr Beer said he considered the tax depreciation schedule as the first step property investors should take to pay less tax.

“Depreciation is different from other deductions in that it’s the only ‘non-cash’ deduction available,” Mr Beer said.

“Other than the cost of the schedule, which is tax deductible, investors don’t need to spend money to claim it.

“It can put thousands of dollars back in an investor’s pocket every year.”

Deductions available through a depreciation schedule, which lasts for the lifetime of the property and must be completed by a quantity surveyor, include those for natural wear and tear, which can be claimed on the building as well as furnishings, appliances and fittings. 

“Once the schedule is prepared, an accountant will use it each tax time to determine the annual depreciation deduction a property investor can claim,” Mr Beer said.

Mr Beer said if the schedule is ordered and prepaid before June 30, an investor can claim 100 per cent of its cost in this year’s tax return.

“Plus, the schedule starts from the property’s settlement date, not the schedule order date,” he said.

“This means if the schedule isn’t ready until after June 30, depreciation deductions can still be claimed for the 2020-21 financial year.

“A schedule will allow the investor to adjust previous tax returns too, so they can claim back missed dollars.”