Every dollar you claim in investment property deductions translates to real dollar savings, and they add up quickly, says Eddie Chung, a property tax specialist and partner at accounting and business advisory firm BDO Brisbane.
When it comes to maximising investment returns, he says there are three big-ticket items from a tax deduction perspective: interest, capital works and depreciating assets.
For most investors who need to borrow to buy an investment property, interest is by far the largest tax deduction they can claim, says Chung.
It can be claimed on the money borrowed to purchase the property, carry out maintenance, and repairs.
The most common mistake is made when people upgrade their family home and turn it into an investment property.
“The conventional wisdom is to pay your home loan as quickly as you can,” says Chung. “When people buy their second property, they redraw the amount from the original loan account.
“What they don’t realise is that the interest on the redrawn amount is now attributable to the new home purchase, so it’s no longer tax deductible.”
Apportion the interest according to the amounts borrowed for rental and private purposes, or open an offset account when you buy your first property.
“Rather than putting money into paying down the loan, put it into your offset account,” says Chung. “Then when you buy your new home, draw money from the offset account. There’s no apportionment necessary because the original loan wasn’t disturbed.”
Another big-ticket item, construction expenditure (capital works), is normally deductible at a rate of 2.5% over 40 years.
When buying your investment property, ask the seller for a depreciation report so you can identify the unclaimed construction expenditure.
“If you can’t obtain that report, get a quantity surveyor to inspect the property and prepare a report estimating what construction expenditure is left for future claims,” advises Chung.
Capital works include extensions, structural alterations or improvements – generally things that are affixed to the building or ground.
Don’t assume the capital works value is equivalent to the property purchase price.
You can claim depreciation on capital expenses that aren’t capital works. Things that aren’t affixed to the building, such as fridges, stoves and washing machines.
The Australian Tax Office has issued a tax ruling listing hundreds of items and providing their suggested depreciation rates.
For assets costing $300 or less, you can claim an immediate deduction for the entire cost. More expensive items must be claimed over the expected life of the asset.
Use the ATO’s estimate or self-assess, says Chung. He notes that the standard estimate may not always fit your own circumstances. For example, he says, “If you buy a stove and the ATO estimates it’s good for 10 years, you might say, ‘No. Because the tenant uses the stove commercially, the effective life will be shorter.’”
Don’t make an unreasonable self-assessment. Your estimate must be defensible.
Another common no-no is inflating the price of an item bought from a related party. “The law specifically provides anti-avoidance rules to neutralise the tax benefit associated with the inflated price.”
Repairs and improvements
One of the most contentious areas is the distinction between repairs and improvements.
“A repair job restores something to its original condition. If you go beyond and improve or replace it, that becomes the purchase of a new asset,” says Chung.
The distinction is important because, generally, a repair cost is totally tax deductible, but an improvement may only be claimed as a capital works or depreciation deduction.
“The tax office does routine checks on people’s alleged repair costs, especially if someone does a big renovation.”
Ask your tradespeople for an itemised invoice so you can prove which costs are repairs.
Doing repairs shortly after buying may lead to unexpected tax consequences.
“If you buy a property and immediately spend a whole bunch of money repairing things, at law that’s not actually a repair,” says Chung. “It’s included in the cost base of your property [asset cost] and you don’t get any deduction upfront.”
Other expenses you’re generally entitled to claim include body corporate fees (excluding capital works), property agent fees and commissions, council rates, cleaning, gardening and insurance.
Whatever it is, get it right, because every dollar you forget to claim costs you, says Chung.
“On the flipside, if you get aggressive and claim deductions you’re not entitled to, you’re in big trouble if there’s an audit.”
With the stakes so high, it pays to manage your investment property carefully.