Property investors are aware of the various specialised tax breaks they are entitled to, but are also liable for some taxes that the majority of non-investor property owners are not, including land tax and capital gains tax (CGT).
In this article, we will talk about allowable tax deductions, CGT and purchasing property using a self-managed superannuation fund (SMSF) to help property investors gain more knowledge of their taxation duties.
A wide range of rental property deductions can be claimed by property investors, that is, if they keep the correct documentation and invoices. Here are some of the common expenses that you, as a property investor, can claim in relation to owning a rental property:
- Advertising for tenants
- Cleaning expenses
- Council and water rates
- Electricity and gas
- Gardening expenses
- Insurance (building, contents, etc.)
- Interest on the investment loan
- Land tax
- Real estate management fees
- Repairs and maintenance
- Reasonable travel costs (for inspection of property)
You can claim the money you spent on things such as white goods, furniture and air conditioners, but they will still be covered by depreciation. The useful life of the item in question is to be utilised to claim the appropriate deduction over a period of years.
Building, construction and borrowing costs
Though not deductible, you can claim building and construction costs under the special building write-off guidelines. Generally, for a rental property constructed after 15 September 1987, a part of the construction costs that is still unclaimed at the date the property was purchased can be claimed.
You can write off the cost at 2.5% every year over 40 years. However, you have to determine the cost of the construction work and the date it was carried out. You can obtain this information from the previous owner, or you can have an estimate provided by a qualified expert, such as a quantity surveyor. If it is a new property, you can get the appropriate cost information from the builder or a quantity surveyor.
Also considered as allowable tax deductions are loan procurement fees and other borrowing costs. However, you can usually claim them over five years.
Some expenses cannot be claimed as a deduction, but are allowed to be included as part of the cost base of a property if it is sold, for CGT purposes.
Together with the original purchase price, below are some items you can add to the cost base:
- Stamp duty on purchase
- Valuer’s fees on acquisition
- Legal costs that are incurred on the purchase and sale of the property
- Advertising expenses on sale
- Auctioneer’s fee
- Capital expenditure on improvements that escalate or maintain the asset’s value (e.g. building a new garage)
Deduction tips for property investors
When negatively gearing, you may want to get an interest-only loan for your rental home because this type of loan guarantees that interest expenses are kept at high levels while not decreasing the loan’s principal. This can benefit you as it will let you offset the interest against your total taxable income. But the decision to take this loan should be determined by your financial situation at the moment and in the future.
If you travel to your property to manage it, you may deduct the travel costs while checking out the property. This would only include, for example, the costs of airline tickets to inspect the property one day and going back home the next day. If you travel to you property and stay for a week-long holiday, tax rules will require you to allocate expenses between deductible and non-deductible items.
CGT and investment property
You need to remember that an investment property that was used in the past as your primary residence can still be considered as primary residence and thus remain CGT exempt for a maximum of six years after the house has ceased to be your family home, as long as you do not own any other primary residence.
Sale of investment property and CGT
You may have to pay CGT for selling a rental property, provided that asset was purchased on or after 19 September 1985.
There will be a capital gain from selling the property when the proceeds from the transaction are higher than the cost base of the property. You will incur a capital loss if the proceeds are lower than the cost base.
If there is a capital gain, you have to apply any capital losses from the present or past year. You may further reduce any remaining net capital gain by using the 50% CGT discount for individuals who have had the home for over 12 months. If the home has been owned for less than a year, the 50% CGT discount can’t be claimed and thus the entire net gain is treated as income and is taxable.
To help pay a possible large CGT tax, always put aside part of the sale proceeds from your rental property.
The effect of building depreciation claims on the cost base of a property
Capital works deductions may decrease the property’s cost base for CGT purposes, if such deductions have been claimed in relation to a rental property. Any depreciable buildings sold with property are subject to special rules.
Investing in property through SMSF
It is not recommended that an SMSF be set up for the simple reason of wanting to invest in property without properly weighing all the risks, benefits and related expenses involved.
Because of the high cost of property, the SMSF may be heavily invested in one type of asset. In this case, it is the duty of the SMSF trustees to consider diversification as one of their investment strategies. If one type of asset underperforms, you can limit your risks with diversification.
There are several tax benefits from investing in property using an SMSF. First, you can claim a 15% maximum tax rate on net rental income when the SMSF is in accumulation mode and 0% while full pension mode. In addition, if the property is sold after being owned for over 12 months, any consequent capital gain will be subject to a maximum capital gains rate of 10% or 0% if in pension mode.
For any deductions for losses or expenses for a rental property acquired using an SMSF, the rate is a maximum of 15%.
For most investors, it may be more beneficial tax-wise to buy a rental property using other structures or under their own names rather than through an SMSF.
Common pitfalls to watch out for
It is common for investors to group different properties under one loan umbrella. For instance, one mortgage may have been taken to finance both the home and the rental property. In this situation, ensure that the loan is structured so that will make it easy for you (and the ATO in the event you’re audited) to identify what part of the loan is for the rental property. After this, you can identify which part of the interest you can claim as an outgoing against your rental income.
You also have to remember that you’re not entitled to a deduction for interest you pay or for any outgoing you gain after the property is no longer being rented, or the part of the loan utilised for private reasons.
Determine all qualified outgoings to be made part of the cost base of the property, because it could potentially cut down any capital gain and raise any capital loss that can be passed on indefinitely to be used against any capital gains incurred in the future.
PJS Accountants offer expertise in managing your tax affairs with a complete range of compliance, corporate and individual tax services. We serve large companies, SMEs, family businesses and individuals. The ever-changing tax laws and requirements could put businesses and individuals at risk. Putting nothing to chance! If you need tax advice or guidance, contact PJS Accountants.