Property Issues for Tax
This year the Tax Office has announced they are targeting excessive or inappropriate deductions made by rental property owners.
Excessive deductions being claimed for holiday homes
Remember deductions can only be claimed for the periods the property is rented out or is genuinely available
Further, deductions should also be limited to the amount of income earned by the landlord when the property
is rented to family or friends below market rates. The following case study from the Tax Office warns of
deductions potentially being disallowed when taxpayers do not limit their deductions to the amount of
income they earn from such an arrangement.
"The taxpayer rented the home to family and friends during the year at less than market rate. They also
provided us with a brochure about the property but the only place the brochure was distributed was at their
business premises, which did not have a large clientele. The nightly rent advertised was much higher than
that of surrounding properties, and the pattern of income did not match the advertised rate, or the
requirement for a five-night minimum stay. The deductions in this case were limited to the amount earned from family and friends because realistic efforts
to let the property were not made – rather, the property was mainly for the taxpayer's personal use. This meant the taxpayer had to pay more tax and a penalty was imposed.
People inappropriately splitting rental income and deductions for jointly owned properties
The Tax Office has also found instances where husbands and wives jointly own a property but split the income and deductions unequally to get a tax advantage for the highest income earner.
"Some people have even included in the income in the low income earner's returns and the deductions in the high income earner's returns," the Tax Office said. "These types or arrangements attract higher penalties where we believe they have been done deliberately."
Claims for repairs and maintenance shortly after a property was purchased
The ATO is also concerned with repairs and maintenance costs incurred by a landlord after the property is purchased. These are commonly referred to as "initial repairs" and are generally capital and therefore not deductible for income tax. These may be available for amortisation or become part of the Cost Base.
The following from the Tax Office illustrates a typical scenario:
"A taxpayer recently claimed repairs and maintenance for a newly acquired rental property which was significantly improved upon purchase. The taxpayer provided an invoice from an interior developer for the "refurbishment" of the property. Further documentation detailed the scope of the refurbishment that included completely stripping the property and replacing old fixtures and fittings with new. The large repairs and maintenance claim was disallowed because initial repairs and improvements to a property are not deductible."
Interest deduction being claimed for the private proportion of loans
Interest expenses incurred with respect to a rental property are only deductible to the extent that the property is being used to produce rental income. Any interest expense referrable to any private use of property is not deductible. You cannot claim an expense for any loan funds that were not used in respect to the rental property.
A straightforward example of this type of arrangement:
"Say you live privately in a two-storey house. Both levels are suitable for living – they have kitchens, bathrooms, etc. You decide to lease the empty top storey while you continue to live on the bottom floor. If you rent out 50% of your house – the top floor – you can only claim 50% off the interest expenses on your mortgage and only other expenses directly related to the occupancy of the top floor . What you can't do is claim 100% of the expenses on that house."
It is vital that taxpayers with rental property interests get their deductions and expense claims right – if they don't, whether by error or by design, they may face harsh penalties.
We are experts in rental property matters.
Please talk to us first if you may have potential issues.