Rental property owners are in the spotlight as the ATO warns them to be careful when claiming rental property deductions.
The most common mistake is not understanding which expenses can be claimed and when, particularly distinguishing between repairs and maintenance versus capital expenses. Other common errors for rental property deductions include over-claiming deductions and lack of receipts to substantiate claims.
The ATO receives extensive information from third-party sources such as the State Revenue Office, banks, councils and property managers, which they can use to cross check the data included in your rental schedules and income tax returns.
It is also important to keep records of any land tax, council rates, water rates, insurance, repairs, maintenance and capital improvements when your rental property is not available for rent. These amounts, which have not been claimed as rental property deductions, can be added to your cost base to reduce any capital gain you may have upon sale. It is crucial to keep these records until you sell the property.
The ATO has many focus areas, however the three significant areas where taxpayers often make mistakes are repairs and maintenance versus capital improvements, interest expenses and borrowing expenses.
Repairs and maintenance versus capital improvements
Owning a rental property may require you to perform general repairs and maintenance, such as replacing a damaged light, tap or broken window. However, expenses that are capital in nature, such as initial repairs on a newly purchased property, purchasing a new dishwasher, or replacing an old kitchen with a new one, are considered capital improvements or new depreciating assets. These expenses can only be deducted over time as capital works or over the useful life of the new depreciating asset.
Interest expenses
Many rental property owners need to be cautious when redrawing or refinancing a loan for their rental property and then using that money for private expenses such as a new car, school fees, or a holiday. You are not allowed to claim the whole amount of interest charged on the investment loan for the year as a deduction.
For example, if you have a $700,000 loan for a rental property and then increase the loan by $60,000 to buy a new car, you can only claim the interest on the initial $700,000 loan, not the interest on the increased $760,000 loan.
Borrowing expenses
It’s important to be aware that costs related to borrowing expenses, including loan establishment fees, lender’s mortgage insurance, and title search fees, are deductible over a five-year period or the life of the loan, whichever is less. If borrowing expenses are not claimed as a rental property deduction, then it is possible that they may be added to your cost base to reduce any capital gain you might have on the sale.
We encourage rental property owners to carefully review their records and ensure that they provide full and complete information, allowing their income tax returns to be prepared correctly. This will help ensure that you claim everything you are entitled to and nothing that you’re not.
Further information can be found via the ATO’s Rental Property Guide 2024. The guide explains how to treat rental income and expenses including how to treat more than 230 residential rental property items.