Understanding rental properties in Australia can be daunting, especially considering the complexities involved. Rental property owners must learn about their tax obligations.
So here is a guide to provide information on rental income and expenses, capital gains tax, tax deductions and more. In this, you will get clear and concise information that can help rental property owners navigate the intricacies of tax law.
Rental properties are an extremely important investment option in Australia since they are seen as a steady source of income for property owners. But with the ownership of a rental property, there come a plethora of responsibilities and obligations.
Rental income is seen as assessable income for tax purposes. Property owners are obligated to include their share of the whole amount of rent received in their tax return. Along with this, rental-related income must be included, for example, reimbursements for expenses and bond payments.
Rental Income and Expenses
Rental income is the money received from renting out a property. This income includes rent, bond and other payments that the tenant makes.
Rental expenses, on the other hand, are the costs incurred while renting out a property. Management fees, repairs and maintenance, interest paid on loans used for the improvement or purchase of the property and insurance fall under these expenses.
It is necessary that you declare all your rental income on your tax return. If you do not do so, it may result in penalties and interest charges.
The Australian Taxation Office lets a rental property owner claim a number of deductions for the rental expenses. Some of these can be claimed immediately, while others have to be claimed over some years. (We will discuss these later in this blog.)
You should keep in mind that not every rental expense is deductible. When a property is used for personal purposes or is being renovated and, as a result, isn’t available for rent, expenses you incur at that time can’t be claimed as deductions.
Rental expenses that can be claimed now
You get to claim an immediate deduction for the following expenses you incur in the same income year. Since you cannot claim a deduction for the cost the tenant paid, you must be the one to incur the cost.
Here’s the list of the expenses that you can claim now:
- advertising for tenants
- council rates, land tax, water charges
- body corporate administrative fund fees and charges
- cleaning, gardening and lawn mowing
- insurance (contents, building, loss of rent, public liability)
- pest control
- interest expenses
- property agent’s fees and commission
- pre-paid expenses
- legal expenses
- repairs and maintenance
To learn more about these expenses, please refer to the official website of the Australian Taxation Office.
Rental expenses that are claimed over several years
Now, let us move on to the deductions that can be claimed over several years. These include:
- Borrowing expenses
- Initial repairs
- Capital expenditure
- Capital allowances
Borrowing expenses
Expenses you incur to take out a loan to purchase a property are called borrowing expenses.
For the eligible borrowing expenses, you can either claim a deduction for 5 years or you can choose to spread it over the term of the loan. Choose whichever is shorter for you.
When the total deductible borrowing expenses are equivalent to or less than $100, these are fully deductible in the income year of incurring them.
Borrowing expenses that you can claim
The following expenses can be claimed as borrowing expenses:
- lender’s mortgage insurance, i.e., the insurance taken out by the lender but it is billed to you
- loan establishment fees
- costs for preparing and filing mortgage documents (it includes solicitors’ fees)
- title search fees charged by the lender
- mortgage broker fees
- stamp duty charged on the mortgage
- fees for a valuation required for loan approval
Capital expenditure
Usually, you cannot claim a deduction for capital expenditure. Still, there are specific circumstances where you may claim capital expenses you incurred relating to your rental property over some years. It includes:
- Capital works
- Substantial renovations
- Improvements
Capital works include expenses you incurred in building the property and carrying out structural improvements, extensions and alterations to the property. The rate is 2.5% per year spread over a period of 40 years and 4% per year spread over a period of 25 years.
If the property was built after 17 July 1985 and is genuinely available for rent or already rented, then only you can claim a deduction for the capital works on rental properties.
Anything that would make an aspect of the property better, more desirable or valuable is considered an improvement. An improvement can also be something that changes the character of the item on which work is being done.
Capital improvements like remodelling a bathroom can be claimed as capital works deductions. Substantial renovations of rental properties are renovations in which substantially all of the building is replaced or removed. Replacement or removal of foundations, interior supporting walls, external walls, roofs, floors, or staircases will be classified as substantial renovations.
The ATO has a detailed guide on what you can claim.
Capital allowances
As per the uniform capital allowance rules, you get to claim a deduction for the decline in value of depreciating assets that are used for income-producing purposes. A dishwasher in a rental property that is rented or genuinely available for rent is a perfect example of such an asset.
Depreciating assets are the items that do not form a part of rental property premises (such as plants). Premises is the actual structure of a rental property’s building.
- Separately identifiable
- Replaced within a relatively short period
- Unlikely to be permanent
- Not a part of the structure of the building
The above-mentioned factors are used to determine if the item is a part of the premises. All of these must be considered together since none of these alone can help you determine this.
Deduction for the item’s decline in value can be claimed, and you can use either:
- Your own reasonable estimate of the effective life
- The effective life determined by the Commissioner for these assets
You also need to keep records to show how you worked out the decline in value.
The decline in value of depreciating assets
Since a depreciating asset has an effective, useful life, it is expected to decline in value over time.
You can claim deductions for this decline in value over its effective useful life on the condition that the said depreciating asset costs more than $300.
Floating timber flooring, curtains, appliances such as fridges or washing machines, carpets and furniture are some examples of these assets.
When it comes to second-hand depreciating assets, there are certain limitations that apply to their decline in value. For assets that cost $300 or less, an immediate deduction can be claimed. However, you cannot claim an immediate deduction for an asset that is part of a set of assets that cost more than $300 together.
Calculating deductions for a decline in value
You can use either of the following methods to work out your deduction for a decline in value:
Prime cost method: In this method, the decline in value every year is a uniform amount of the original value over the effective life of the asset. As a result, you claim a lower proportion, which is constant every year.
Diminishing value method: In this method, the decline in value every year is a constant proportion of the remaining value of the asset. Resultantly, you claim higher deductions in the early years of the effective life of the asset.
Initial repairs
The expenses incurred to remedy damage, deterioration or defects that are already present at the time you acquire the property are considered of a capital nature. Based on the kind of expense incurred by you, you may get to claim a deduction for either capital allowances or capital works.
Repairs on a newly acquired rental property
Initial repairs done to rectify deterioration, damage or defects that were present at the time of acquisition of the property cannot be claimed as an immediate deduction. However, you may be able to claim these over a couple of years as capital works deductions.
Replacing an asset
The cost of replacing assets like a complete fence may be claimed as capital works. The cost of replacing a depreciating asset, on the other hand, may be claimed as deductions for a decline in value.
To know about the process and the kind of deductions you can claim, please refer to the official website of the ATO.
Rental expenses that can’t be claimed
After learning about the rental expenses that can be claimed immediately and over a couple of years, let us pay attention to the expenses that can’t be claimed.
You cannot claim the following as borrowing expenses:
- Loan balances for the property
- Interest expenses (since they are claimed separately)
- The amount you borrow for the property
- Repayments of principal against the loan balance
- Legal expenses, including conveyancers’ and solicitors’ fees for buying the property (since it is a capital expense)
- Insurance premiums where your loan is going to be paid out in the event you become unemployed, disabled or die (because it is a private expense)
- Stamp duty incurred when you acquire a leasehold interest in property
- Stamp duty charged by state and territory government on the purchase (transfer) of the property title (because it is a capital expense)
- Borrowing expenses on a portion of the loan used for private purposes (such as money used to purchase a car)
Capital expenses may be included in the ‘cost base’ of the property. As a result, you might be able to reduce the CGT (capital gains tax) amount you pay at the time you sell the property.
There are specific conditions applied to the second-hand depreciating asset.
There are other expenses you cannot claim:
- Expenses that aren’t paid by you, for instance, electricity or water charges paid by the tenants.
- Disposal and acquisition costs, which include the purchase cost, advertising and conveyancing costs (these are generally included in the cost base of the property, and these would reduce any CGT at the time you sell the property).
- GST credits for anything purchased to lease the premises. Goods and services tax does not apply to residential rental properties, but when you claim the expense as a deduction, you claim the entire amount you have paid (which includes GST, if applicable).
Rental income and expenses can be too complex for a lot of people. It can be difficult to keep track of everything, especially with deductions that can or cannot be claimed or claimed over several years.
When things get overwhelming, you should contact a professional who can help you make the process easier and hassle-free. You can contact Clear Tax Accountants, a team of professional and experienced accountants, for your tax matters. You can also refer to the ATO’s website to learn more about rental income, expenses and deductions.
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