Navigating the labyrinth of property tax accounting is no small feat. It’s a journey fraught with potential pitfalls and lethal mistakes that can cost you dearly. In the realm of property tax, a single misstep can lead to financial penalties, or, worse, legal consequences. This article aims to shine a light on these potential pitfalls, specifically focusing on the Australian context. Let’s delve into the first two lethal mistakes your property tax accountant might be making.
Over-Claiming Expenses in Rental Property Tax Returns
Over-Claiming Expenses in Rental Property Tax Returns
The first lethal mistake revolves around the over-claiming of expenses in rental property tax returns, including initial repairs. This is a common error made by individuals who, in an attempt to maximise their returns, end up claiming more than they should.
The Australian Taxation Office (ATO) has stringent rules regarding what can and cannot be claimed as expenses for rental properties. For instance, initial repairs on a property are not considered deductible, as they are usually seen as capital expenses. Over-claiming such expenses can lead to discrepancies in your tax return, which can trigger an audit by the ATO.
To avoid this mistake, it’s crucial to understand what constitutes a legitimate expense. Regular maintenance costs, interest on loans, and property management fees are typically claimable. However, improvements or enhancements to the property are usually not. When in doubt, consult with a professional or refer to the ATO’s guidelines on rental property expenses.
Lack of Preparation for Tax Time
The second lethal mistake is a lack of preparation for tax time. This might seem like a minor oversight, but it can have significant repercussions. Being unprepared can lead to rushed decisions, missed deductions, and errors in your tax return.
Preparation for tax time should be a year-round activity. It involves keeping accurate records of all transactions related to your property, including rental income, expenses, and capital improvements. It also means staying updated with the latest tax laws and regulations.
A well-prepared tax return is not only accurate but can also help maximise your deductions. For instance, keeping track of all your property-related expenses can help you claim all the deductions you’re entitled to. On the other hand, a poorly prepared tax return can lead to missed deductions and increased chances of an audit.
Incorrectly Claiming Interest on the Family Home
One of the most common mistakes that property tax accountants make is incorrectly claiming interest on the family home. This is a grave error, as the Australian Taxation Office (ATO) does not permit such claims. However, it is entirely legal to claim interest on a loan used to purchase an investment property against income. But beware, if the property is jointly owned, you cannot shuffle around deductions like interest against the person with the higher income.
The ATO is particularly vigilant about rental property owners understanding how to correctly apportion loan interest expenses, especially when part of the loan was used for private purposes or was refinanced for some private purpose. As the ATO’s assistant commissioner Tim Loh warns, “If your loan also includes a private expense, such as for a new car or a trip to Bali, you can only claim an interest deduction for the portion relating to producing your rental income”.
Overlooking Investment Property Expenses
Another lethal mistake that property tax accountants often make is overlooking investment property expenses. There are a multitude of expenses that can be claimed against the income from an investment property. These include gardening, security costs, and cleaning. It’s also possible to claim many, like next year’s insurance premium or subscription to a property magazine, this year.
However, many people, as Loh advises, over-claim expenses or claim for improvements to their own private property. This is an area the ATO is determined to focus on this year.
Another big area that seems to be causing issues is with regard to interest deductibility, particularly where it is a new build.
Prior to 1 July 2019 things were a little different. Changes that were introduced into law have changed the landscape for deductions for interest deductions (and other costs, which we will discuss below).
The costs associated with holding vacant land (this will include interest, council rates, land tax) will no longer be deductible. Unfortunately, there are no ‘grandfathering’ provisions in the legislation. So what this means is that if you held vacant land prior to 1 July 2019 you are still denied these deductions going forward. Ouch !!
These costs will, however be able to be included in the cost base. What this means is that when you eventually sell the property these costs will reduce the capital gain you make on sale.
If the vacant land is held by a company, a superannuation fund THAT IS NOT an SMSF, a public unit trust, managed investment trust or a partnership or unit trust which is made up of those type of entities then the new law doesn’t prevent you from claiming these holding costs.
There is also an exclusion if you are carrying on a business. So, if you are a property developer and hold vacant land as part of your property development business then the legislation won’t affect you.
VACANT LAND AND INTENTION TO CONSTRUCT RESIDENTIAL RENTAL PROPERTY
Peter and Jim acquire vacant land with the intention to construct a new residential property which they will rent out.
Peter and Jim will not be able to claim a deduction for interest, council rates, land tax or maintenance costs until
– The construction of the residential investment property is complete
– Approval has been granted to occupy the property; AND
– The property is genuinely available for rent.
Note that a ruling TR 2021/D5 has come out and paragraph 27 in Example 5 says
Example 5 – new construction
25. Harry purchases vacant land on 1 July 2019 and builds a house on the land. He obtains the occupancy certificate on 9 February 2020. Harry lists the property with a real estate agent for lease on 1 March 2020. Any holding costs that Harry would otherwise be entitled to deduct from 1 March 2020 will not be denied by section 26-102, as from this date the house is lawfully able to be occupied and available for lease.
Loss or outgoing relating to holding land
26. Subsection 26-102(1) clarifies that any interest or borrowing costs to acquire land are included as a cost of holding land. Examples of other costs of holding land include council rates, land taxes and maintenance costs.
27. In the context of sections 26-102, we do not consider the costs of constructing a substantial and permanent structure on the land, or any interest or borrowing costs (to the extent they are associated with construction), to be a loss or outgoing related to holding land.
So although the interest on the loan for the vacant land won’t be deductible until the above events occur the interest on the loan for the construction of the building should be if it is planned to be used for income-producing purposes.
There is also an exclusion if you are carrying on a business. So, if you are a property developer and hold vacant land as part of your property development business then the legislation won’t affect you.
Incorrectly Claiming Repairs and Upgrades
Most repairs to an investment property, or upgrades, can be claimed – except if they’re working to rectify defects on a property when it’s first bought. Those are not deductible, although can be put against capital gains tax when the home is sold.
“For the first 12 months, if you claim a deduction for a repair, you have to look at whether it’s an initial repair or whether it is genuinely deductible,” says Mark Chapman, director of tax communications at tax services company H&R Block.
Claiming Deductions for Personal Expenses
The fourth lethal mistake that property tax accountants often make is claiming deductions for personal expenses. This is a common error that can lead to serious consequences. The Australian Taxation Office (ATO) has clear guidelines on what constitutes a personal expense and what doesn’t. For instance, you cannot claim deductions for the distance travelled from home to work. However, you can claim for travel from your office to another work-related meeting.
Moreover, when it comes to phone expenses, you must only claim for work calls, not your entire bill, which would likely include a high percentage of personal calls. Understanding the fine line between personal and work-related expenses is crucial to avoid this mistake.
Forgetting to Keep Receipts or Records of Expenses
The fifth lethal mistake is forgetting to keep receipts or records of expenses. This might seem like a minor oversight, but it can have significant repercussions. The ATO can call on you to provide receipts and evidence up to five years from the date you’ve lodged a claim. Therefore, it’s essential to keep track of all your receipts and records of expenses. This includes proof of work-related expenses, bank interest statements, and rental property income, to name a few.
Claiming Personal Expenses for Rental Properties
Another common mistake is claiming personal expenses for rental properties. For instance, if you usually rent your property but decide to move in for a few months between tenants, you can’t claim for the period you reside there. Understanding the rules around rental properties and what can and cannot be claimed is crucial to avoid this mistake.
In conclusion, property tax accounting is a complex field with numerous potential pitfalls. By being aware of these lethal mistakes and taking steps to avoid them, you can navigate the property tax landscape more confidently and effectively. Remember, when in doubt, it’s always best to consult with a professional or refer to the ATO’s guidelines.
