At Quantum Partners we lodge hundreds of tax returns each year for clients who own investment properties. These may be residential or commercial properties and either wholly owned, jointly owned or via partnerships, family trusts or SMSFs.
Below is a summary of tips to manage those properties and ensure the optimum tax results come tax time and also during the period of acquisition and sale.
Some may seem obvious, but are nevertheless highlighted, as from our experience they represent some of the more common misunderstood issues around property investing.
1. Keeping the right records
You must have evidence of your income and expenses so you can claim everything you are entitled to. This normally includes but not limited to advertising cost, council rates, insurance, repairs, strata levies and water rates.
Capital gains tax may apply when you sell your rental property. So keep records over the period you own the property and for five years from the date you sell the property.
2. Make sure your property is genuinely available for rent
Your property must be genuinely available for rent to claim a tax deduction for the holding costs mentioned above. This means that you must be able to show a clear intention to rent the property. Advertise the property so that someone is likely to rent it and set the rent in line with similar properties in the area. Avoid unreasonable rental conditions that may deem the property to be uncommercially advertised.
3. Getting initial repairs and capital improvements right
You can’t claim initial repairs or improvements as an immediate deduction in the same income year you incurred the expense.
- Repairs must relate directly to wear and tear or other damage that happened as a result of you renting out the property. Initial repairs for damage that existed when the property was purchased (e.g. replacing light fittings or repairing damaged floor boards are not immediately deductible. Instead these costs are added to the cost based and used to reduce your profit when you sell the property.
- Ongoing repairs that relate directly to wear and tear or other damage that happened as a result of you renting out the property (e.g. fixing the hot water system or part of a damaged roof are classed as a repair and can be claimed in full in the same income year you incurred the expense.
- Replacing an entire structure like a roof when only part of it is damaged or renovating a bathroom is classified an improvement and not immediately deductible. These are building costs which you can claim at 2.5% each year for 40 years from the date of completion.
- If you completely replace a damaged item that is detachable from the house and it costs more than $300 (e.g. replacing the entire hot water system) the cost must be depreciated over a number of years.
4. Claiming borrowing expenses
If your borrowing expenses are over $100, the deduction is spread over five years. If they are $100 or less, you can claim the full amount in the same income year you incurred the expense. Borrowing expenses include loan establishment fees, title search fees and costs of preparing and filing mortgage documents.
5. Claiming purchase costs
You can’t claim any deductions for the costs of buying your property. Such costs include legal/conveyancing fees and stamp duty. If you sell your property, these costs are then used when working out whether you need to pay capital gains tax. We always recommend that you provide us source documents that evidence any property purchases you make which we will file for you indefinitely. These documents include front page of the contract, legal fees and settlement sheet.
6. Claiming interest on your loan
You can claim the interest paid as a deduction if you take out a loan for your rental property. If you use some of the loan money for personal use you can’t claim the interest on that part of the loan. You can only claim the part of the interest that relates to the rental property. It is also prudent to have a completely separate loan for an investment property purchase and not be mixed with your home loan. If you don’t have a mortgage broker to assist you with your purchase, please contact us in advance to assist in getting your finance structured correctly.
7. Getting construction costs right
You can claim certain building costs, including extensions, alterations and structural improvements as capital works deductions. As a general rule, you can claim a capital works deduction at 2.5% of the construction cost for 40 years from the date the construction was completed. If the previous owner claimed a capital works deduction they are required to give you the information they used to calculate the costs so it always pays to ask them for this. If they didn’t use the property to produce assessable income you can obtain an estimate from a professional quantity surveyor. We can recommend one to you if required. It is also worth noting that legislation has just passed that affect how much deduction can be claimed on second hand residential investment properties exchanged after 9 May 2017.
8. Claiming the right portion of your expenses
If your rental property is rented out to family or friends below market rate, you can only claim a deduction for that period up to the amount of rent you received. You can’t claim deductions when your family or friends stay free of charge, or for periods of personal use.
9. Co-owning a property
If you own a rental property with someone else, you must declare rental income and claim expenses according to your legal ownership of the property. As joint tenants your legal interest will be an equal split, and as tenants in common you may have different ownership interests.
10. Getting your capital gains right when selling
When you sell your rental property, you will make either a capital gain or a capital loss. This is the difference between what it cost you to buy and improve the property, and what you receive when you sell it. If you make a capital gain, you will need to include the gain in your tax return for that financial year. If you make a capital loss, you can carry the loss forward and deduct it from capital gains in the same or future years.
