INVESTMENT PROPERTY TAX DEDUCTIONS - THE ULTIMATE GUIDE
INVESTORS TAX RETURN CHECKLIST
As property investors preparing your tax return is a necessary, though sometimes an unwanted, part of holding your investment property.
So, what sort of things should you be collating when preparing your income tax returns?
Hopefully this checklist will help you put together the information need to give to your property tax accountant
RENTAL INCOME
Rental and other rental-related income is the full amount of rent and associated payments that you receive, or become entitled to receive, when you rent out your property.
This can either be paid to you directly or through an agent such as a property agent or AirBNB, etc.
To assist your accountant, it is a good idea to provide them with
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Annual Rental Summary Statement from Agent
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Summaries of Expenses Reimbursed
WHAT CAN I CLAIM ?
Before looking at what you claim one of the important aspects is
MUST BE AVAILABLE FOR RENT
It is important that the investment property is available for rent.
This doesn’t mean that the property has to have been rented but you have taken reasonable efforts to try and rent the property.
Negotiations with agents, advertising in local papers and other such things go toward proving that you have made the property available for rent. This can be extremely important where you had the property vacant for some period and must prove to the ATO that the property was available for rent.
If the property was not available for rent, then the expenses will need to be apportioned. You also need to be careful that the rent is not set so high that the property would generally not attract a tenant for the area in which it is located as the ATO could argue you have set the rent so high so as not to attract a tenant and therefore it was not available for rent.
If you merely intend to make the property available for rent and don’t take any steps to make it available for rent, then this will probably mean the expenses won’t be deductible until such steps are taken.
Even if the property has been taken off the market as you intend to do some repairs to the investment property then interest expenses and other costs such as council rates, etc. will still be deductible provided
- You don’t leave the premises vacant for such a long period of time
- The expenses are incurred with the view to gaining future income; and
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You continue to make efforts to undertake repairs on the property.
If you merely intend to make the property available for rent but don’t actually take any steps to do so, then the ATO does not consider this to be sufficient. Steps that will help you in arguing that you have made the property available for rent include
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Listing the property with an agent or on a website such as Airbnb, etc
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Making sure the rent is set at a commercial rate considering the area in which it is located, age of the building, restrictions (e.g. pets), etc
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Ensuring that you don’t limit the times that the property is used E.g. a beach house which you don’t list or make available for rent during the holiday season e.g. Christmas so you and your family and friends can spend time there.
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INVESTMENT DEDUCTIONS
There are a number of deductions that a property investor incurs for which you may be entitled to claim an immediate deduction in the year the expense was incurred including
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Advertising For Tenants
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Bank charges
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Body Corporate Fees and Charges
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Cleaning
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Local Council Rates
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Electricity and Gas
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Gardening and Law Mowing
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Insurance - Building, Contents, Public Liabiliy, Landlords
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Interest on Loans
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Land Tax
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Legal Expenses
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Mortgage Discharge Expenses
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Pest Control
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Property Agents Fees and Commissions
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Quantity Surveyor Fees
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Repairs and Maintenance
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Registered Tax Agent Fees
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Water Rates and Charges
TRAVEL EXPENSES
From 1 July 2017 travel expenses in relation to a residential investment property are no longer tax deductible.
However, the change to legislation does not impact those individuals who hold commercial properties or are carrying on a business of property investing.
Note as well if the residential investment property is held by a company or a unit trust (and the units are held by a company) then the travel expenses can still be claimed.
INTEREST EXPENSES
This can be quite a complex area and probably causes the most confusion and disagreements amongst advisers.
The ATO look at the ‘use test’ to determine the deductibility of interest.
FC of T v Munro is a tax case and it established this principle and looks at the application of how the funds are used to determine interest deductibility.
Taxation Ruling 95/25 says that generally, the starting point for determining the essential character of an interest expense is to determine the ‘use’ to which the borrowed funds have been put i.e. you trace the borrowed funds.
I will try and go through a few examples and common questions asked by clients to give you an idea of the deductibility of interest in each of these scenarios.
Can you claim an interest deduction for vacant land on which you intend to build an investment property?
Prior to 1 July 2019 things were a little different.
Changes that were introduced into the law have changed the landscape for deductions for interest deductions.
The costs associated with holding vacant land (this will include interest, council rates and 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.
There is also an exclusion for carrying on a business. So, if you are a property developer and hold vacant land as part of your property development business then the changes to the law won’t affect you.
What is considered to be vacant land ?
The Explanatory Memorandum provides some guidance and says that land is vacant, for the purposes of these amendments, if there is no building or other structure on the land that is substantial and permanent in nature and in use or ready for use.
In this context, land does not have to refer to the whole of the land on a property title but could refer to part of the land on a property title. For example, if a property title includes two areas of land, one containing a factor and the other undeveloped, the part of the property title containing the factor has ceased to be vacant land, while the undeveloped area remains vacant land.
Chelsea owns a block of land. She intends to eventually build a rental property on the land.
However, while the block of land is fenced and has a large retaining wall, it currently does not contain any substantial or permanent building or structure.
As the property does not have a substantial permanent building or structure on it, it is vacant land and Chelsea cannot deduct any holding costs she may incur in relation to the land.
Peter and Jim acquire vacant land with an 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;
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– The property is generally available for rent.
It is important to note a ruling TR 2021/D5 has been issued by the ATO and at paragraph 27 in Example 5 it states
” 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 the land
26. Subsection 26-102(1) clarifies that any interest or borrowing costs to acquire land are included as cost of holding land. Examples of other costs of holding land include council rates, land taxes and maintenance costs.
27. In the context of section 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 for income producing purposes.
This is going to make loan structuring extremely important to maximise your interest deductions and to avoid apportionment of loan interest deductibility during the construction phase.
Can you claim an interest deduction for a redraw from a line of credit ?
The interest deduction on the redraw always depends on the ‘use test’.
If you had an investment property loan and you redraw the funds for private purposes, e.g. living expenses, then the redrawn component will be non-deductible.
If, however the redrawn funds were used for investment purposes then the interest on the redraw would be deductible.
Taxation Ruling TR 2000/2 examines the treatment and consequences of payments to lines of credit (LOC) more than the required amount and the subsequent redrawing or withdrawal of those funds.
It is considered that a repayment to a LOC more than the requirement amount is a permanent reduction to this debt.
Repayments of amount to a LOC do not create a debt due to the borrower but simply allows the borrower to then draw those funds from the LOC to an agreed limit.
These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant.
If you have an LOC which contains some deductible and non-deductible components, then apportionment of the interest deduction may be required.
Paragraphs 19-20 of TR 2000/2 contain formulas which can be used to calculate the income producing portion of the interest.
The ruling accepts that it would be unnecessarily onerous, to require a manual daily apportionment calculation.
It isn’t acceptable where you have one loan with private and investment debt to allocate specific amounts to specific portions of the debt.
For example, if you had a total loan of $300,000 and $200,000 of that debt was used to purchase an investment property and $100,000 was used for a motor vehicle and you subsequently made a $50,000 repayment on the total loan you couldn’t say the $50,000 related to the repayment of the loan for the motor vehicle.
You would need to apportion the $50,000 repayment across both the investment property dent and the motor vehicle debt as it is one consolidated loan.
LAND TAX - BE CAREFUL
Land Tax
Land tax liabilities may be deductible depending on when the land tax liability arises.
ATO ID 2010/192 used to provide guidance on this issue, although the guidance has been moved into the ATO rental property guide which states
“Land Tax Liabilities may be deductible, depending on when the land tax liability arises. The timing of when you incur the liability to pay land tax will depend on the relevant State legislation.
Your liability to pay land tax does not rely on the lodgement of a land tax return or on the taxing authority issuing a land tax assessment.
In many states, the year in which the property is used for the relevant purposes determines when you are liable, even if an assessment does not issue until a later date.
When you receive land tax assessments in arrears, the amount of land tax is not deductible in the income year in which you pay the arrears”
Unfortunately this is a common error where I have seen previous accountants claim the land tax in arrears assessment in one income year.
They must be claimed in the income year to which the liability relates.
If the land tax is deductible in an earlier income year where the property was used to derive assessable income, you should be able to amend prior years’ income tax returns to claim the deduction (provided that the amendment period of the return has not expired)
If the amendment period for any earlier returns has expired, you should check whether you can make an ‘out of time’ objection against the assessment.
While the general objection time limits are based on the time limits that apply for the purposes of amending an assessment the tax laws allow you to lodge a late objection and request that the Commissioner deal with it as if it had been lodged within the time limit. It will then be up to the Commissioner’s discretion to grant such a request.
If the amendment period has expired and the Commissioner will not allow an out of time objection then the land tax incurred in the earlier years would form part of the cost base what we called a 3rd element cost.
Can you claim an interest deduction for vacant land on which you intend to build an investment property?
Frequently Asked Questions
Rental and other rental-related income must be reported when filing your tax returns. This income is the total amount of rent and associated payments that you receive, or become entitled to receive, when you rent out your property. This can be paid directly to you or through an agent such as a property management company or Airbnb.
Yes, it’s important to show that reasonable efforts were made to rent out the property, such as negotiations with agents, advertising, etc. If the property was not rented but was available for rent, certain expenses can still be deductible. However, if the rent was set so high that it would generally not attract a tenant, the ATO could argue that it was not truly available for rent.
There are numerous deductions that you may be entitled to claim immediately in the year the expense was incurred. These include advertising for tenants, bank charges, body corporate fees, cleaning, local council rates, electricity and gas, gardening and lawn mowing, insurance, interest on loans, land tax, legal expenses, mortgage discharge expenses, pest control, property agent’s fees and commissions, quantity surveyor fees, repairs and maintenance, registered tax agent fees, water rates and charges.
From 1 July 2017, travel expenses related to a residential investment property are no longer tax deductible. However, this doesn’t impact individuals who hold commercial properties or are carrying on a business of property investing. Also, if the residential investment property is held by a company or a unit trust, the travel expenses can still be claimed.
The ATO uses the ‘use test’ to determine the deductibility of interest. This involves tracing the borrowed funds and understanding how they were used. For example, if you have a loan for an investment property and you redraw funds for private purposes, the interest on the redrawn component will be non-deductible. However, if the redrawn funds were used for investment purposes, the interest on the redraw would be deductible.
