Thinking of owning an investment/rental property or maybe you already own one but you’re not sure about the treatment of transactions when it comes to tax time? Well, this one’s for you!
A rental (or investment) property is basically a property owned by you that generates income through a contract of lease to someone else - someone who lives in your house and pays you rent. It can actually be rented out in any form, as long as the owner is having an inflow of money from it.
The thing is, rental income is not ‘free money’. The ATO is going to tax you on it, so we need to be clear about what rental income is and what deductions you can claim against it to bring the taxable income down and reduce your tax bill too!
This one is pretty easy - keep track of all monies your lessee is meant to pay to you and what they actually did pay to you for the financial year.
You can claim a deduction for the costs you incurred in relation to earning rental income, but naturally there are some rules around what and how much you can claim, and of course you need to keep good records.
In the tax return, there’s actually a rental property schedule to complete - like a worksheet. For everything you report in there, you need to keep the supporting documents.
For the once off documents, like purchase contracts and lease agreements, we recommend you keep a copy of all of these in the Google Drive folder that you share with us.
For the income, your accountant wants to see the lease agreement as well as the bank statements showing the money received.
For the deductions, your accountant wants a spreadsheet showing all transactions, the bank statements ideally, and the receipts for everything please. We get our clients to upload it to the Google Drive folder for safe keeping.
Note: The general rule is you can claim a deduction for interest expenses relating to the rental/investment property. If the property/asset is being used for private purposes, then interest expenses incurred in that period can no longer be deducted for tax purposes. If the purpose is shared (part personal, part investment) then only claim the appropriate amount of total interest. Keep in mind that capital gains can be an issue later.
You can claim a deduction for prepaid expenses of:
You may have to spread the expenses to over two or more years if the prepayment incurred does not meet the criteria stated above.
What is the difference between repair and maintenance? When something gets broken or stops working, repair is done for the restoration of the latter. While maintenance are the necessary procedures/routine done to prevent the damage of the property.
Examples of improvements:
Here are some costs that can be included as a deduction for rental properties:
These are the costs that you can’t claim as tax deductions:
Your accountant would love you to provide a depreciation report from a quantity surveyor - if you don’t have one we recommend getting one because you could be missing out on deductions. A quantity surveyor can estimate the depreciable value of the plant & equipment and capital works so you can claim a depreciation even if you don't have receipts.
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Both you and the other owner need to record information about the property in your individual tax returns, assuming you hold the ownership in your own name and not via a Trust or other entity.
Since only half of the property is owned by you, only half of the income and expenses would be apportioned to be filled on your tax return.
Let’s say the property earned a rental income of $50,000 and incurred expenses of $15,000, making the total rental income $35,000. Income and expenses would be apportioned to 50% to both of you, which would also result in a net rental income of 50% to both of you You get taxed on $17,500.
How much interest expense can you claim as a deduction?
Since the loan is intended not only for the rental property but also the purchase of a new car, you must do the following computation to work out the interest for the rental property alone:
Total interest expense x (rental property loan divided by total borrowing) = deductible interest
$10,000 x ($75,000 divided by $100,000) = $7,500
As a result, you can claim $7,500 as an allowable deduction for tax purposes.
This one’s interesting and a bit tricky. Take note, rental income exists as long as either the whole property or part of the property is being rented.
Let’s say you own the property outright (no mortgage), and earn rental income of $30,000 for the room, and incurred expenses of $8,000 for the period it was rented. We need to include all of this info in your return, and you will be taxed on the $22,000 net rental income.
Note: this means part of your property is income-generating (so is part investment and not your private property) so might result in capital gains issues down the track. More on that later!
Here’s a more complicated scenario…
Assuming you took a loan of $400,000 for the purchase of the whole property and your total interest expense was $5,000 per year.
How much interest expense can you claim for the room being rented out?
The best thing to do is to grab the floor plan of the property. You can make a percentage based on the size of the room being rented out.
Whole property size - 500 sqm
Room being rented out - 100 sqm
Total interest expenses x (room being rented out divided by whole property size)
$5,000 x (100 sqm divided by 500 sqm) = $1,000
When you start renting out the property, then we start including that in your tax return for the ATO.
The computation of interest for the loan, if any, still applies to the whole amount of loan but the interest expense that is claimable as a deduction only applies to the period when the property was rented out.
Let’s say there’s a loan amount of $400,000 for the property that you purchased and your total interest expense is $35,000 over the properties lifetime, and about $5,000 per annum. For this financial year, you lived in the property for 8 months and for the remaining 4 months you transferred to a different house and decided to rent out the property.
In the above scenario you would do the following calculation:
Total interest expenses x (months the property was rented out divided by months in a year)
$5,000 x (4months divided by 12 months) = $1,667
You can claim an amount of $1,667 as interest expense for the rental property.
Same rules apply to this from the example above, but the opposite! You can claim a portion of the interest, related to the period it was rented out and you cannot claim the rent related deductions after you stop renting the property to others.