Investing in rental properties can be a lucrative venture, but it’s essential to navigate potential tax traps and pitfalls to ensure compliance with the Australian Taxation Office (ATO) regulations. Recent findings indicate that a significant number of residential rental property investors have been incorrectly reporting their returns. In this article, we will explore some common tax-related issues that property investors should be mindful of to avoid unnecessary complications. It is crucial to consult with a tax professional or financial advisor for personalised advice regarding your specific circumstances.

 

Apportionment of rental income and deductions

When a rental property is jointly owned by multiple individuals, the income and deductions should be divided according to each owner’s share of legal ownership. Spouses often share joint tenancy, resulting in a 50:50 split. It’s important to note that the spouse with a higher tax rate cannot claim a disproportionate share of deductions if the payments were made from their personal bank account.

 

Private use

Expenses incurred for private purposes, such as when the property is occupied by yourself, relatives, or friends without charging market rent, are not tax-deductible. It’s crucial to differentiate between periods of private use and rental income generation.

 

Interest deductions

Interest costs associated with debt used to acquire a rental property are generally tax-deductible. However, if a loan secured against the rental property is used for personal purposes, such as purchasing a car or renovating your primary residence, interest deductions can only be claimed on a proportional basis. Care should be taken during refinancing to ensure the tax deductibility of interest related to the rental property is not compromised.

 

Repairs vs. improvements

Immediate deductions can be claimed for genuine repair expenses incurred to fix wear and tear issues or broken items in the rental property. However, if the work involves replacing the entire asset, it is considered a capital improvement and can be claimed at a rate of 2.5% per annum. It is important to differentiate between repairs and major renovations.

 

Initial repairs

Repairs made before earning rental income from a property are not tax-deductible. If you need to make initial repairs before tenants can move in, keep track of the expenses as they can offset any capital gains when the property is sold in the future. Whenever possible, delay non-urgent repairs until after tenants have begun renting the property.

 

Travel costs

Travel expenses incurred while visiting your rental property for maintenance or management purposes are no longer tax-deductible. This change especially affects investors who own properties in different states. Exceptions exist for investors engaged in the business of letting rental properties, although this is relatively rare.

 

Depreciation

Second-hand depreciating assets acquired as part of a rental property cannot be immediately written off against rental income unless you are in the business of letting rental properties. However, the unclaimed depreciation can contribute to a capital loss when the property is eventually sold. Keep track of these amounts for future reference.

 

Cash jobs

Avoid accepting cash payments from tradespeople without receiving a proper invoice that satisfies substantiation rules. Even if the tradesperson offers a lower quote, failing to obtain a valid invoice can result in the loss of tax deductions. Ensure that the tradesperson complies with their own tax obligations while protecting your entitlement to deductions.

 

Holiday homes

If you own a holiday home that is also rented out for short-term stays, be aware that the ATO requires the property to genuinely be available for rent, even during peak demand periods. Limitations on deductions for mortgage interest, rates, land taxes, repairs, and maintenance may apply if the property is primarily used for personal purposes. Proportionate deductions are allowed for limited personal use if there is a genuine intent to generate rental income.

 

Conclusion

Navigating the tax intricacies of rental property investments is essential to ensure compliance and maximise your returns. The traps and pitfalls mentioned above highlight some key areas where investors often encounter issues. Seek professional advice to tailor your tax strategy to your individual circumstances. By understanding and adhering to the tax regulations, you can safeguard your financial interests and have a successful rental property investment journey.

If you have any concerns or questions, don’t hesitate to reach out to Regency Partners for assistance.