It’s the start of a new financial year and the 1.8 million Australians (approximately eight per cent of the population) who own an investment property will be preparing their income tax returns.
A number of warnings were issued by the Australian Taxation Office (ATO) in the lead-up to the end of financial year, suggesting these investors should be careful when lodging their claims.
Key aspects the ATO advised they will be checking are excessive deductions for holiday homes, husbands and wives who split rental income and deductions for jointly owned properties, claims for repairs and maintenance shortly after a property has been purchased and claiming deductions for the period a property is rented or genuinely available for rent.
To help property investors to ensure their deductions are claimed correctly, here are four key aspects and tips to watch for when claiming depreciation on an investment property:
1. Claim deductions for the portion of the year a property is available for rent
Rental property owners should only claim deductions for the periods their property is rented out or that it is genuinely available for rent. Holiday home owners in particular must be careful to ensure deductions are claimed correctly.
Ensuring deductions are claimed for the portion of the year a property is income producing or available for rent can easily be resolved by requesting a tax depreciation schedule. A BMT Tax Depreciation Schedule will outline deductions from the date of settlement and will only include the deductions available for the remaining part of the year.
2. Don’t claim capital works and plant and equipment deductions incorrectly
Investors who lodge self-assessed deductions often make the mistake of incorrectly allocating plant and equipment assets as capital works deductions or classifying plant and equipment items as capital works.
This can result in two issues for the investor: they could over-claim, resulting in unwanted attention from the ATO, or they could under claim and miss out on receiving the maximum deductions available.
These mistakes generally occur because investors do not have the knowledge of depreciation legislation necessary to separate items appropriately and they have not sought adequate advice or requested a tax depreciation schedule.
Capital works items represent the structural component of the property, including fixed items. Examples include walls, roofs, doors, wiring and tiles. In residential properties, capital works deductions for these items can be claimed at a rate of 2.5 per cent for 40 years for buildings in which construction commenced after the 15th of September, 1987. If any renovations have occurred within legislated dates, capital works deductions may still apply for the owner, even if these renovations have been completed by a previous owner.
Plant and equipment assets are the mechanical and removable assets contained within an investment property. Examples include hot water systems, carpets, smoke alarms, ceiling fans, air conditioning units, garbage bins and even shower curtains. Unlike capital works, the age of an item does not affect plant and equipment deductions. Each asset is assigned an individual effective life by the ATO.
To ensure that deductions are correct and maximised, a specialist quantity surveyor will complete a site inspection as part of the process of arranging a depreciation schedule. This inspection allows a depreciation expert to take photographs and note every asset within the property. They will also perform the necessary searches to find any details required to estimate construction costs, including those for any renovations which have occurred. A depreciation schedule will outline all deductions available for capital works and separately itemise all deductions for plant and equipment items.
3. Claim repairs, maintenance and capital improvements correctly
Expenses for repairs and maintenance are claimed differently than capital improvements. The ATO provides clear definitions of each to help investment property owners to ensure these claims are made correctly.
Repairs (work completed to fix damage or deterioration to a property) and maintenance (work completed to prevent deterioration to a property) should be claimed as an immediate deduction in the year an expense occurred. However, any capital improvements (work which improves the condition or value beyond its original state at the time of purchase) must be depreciated and claimed as a capital works deduction or as plant and equipment depreciation.
If a property investor plans any work to their income producing property, they should consult with their quantity surveyor prior to commencement to discuss the implications this may have to the deductions they can claim. Any assets removed may have remaining depreciation available to be claimed as an immediate write-off in the year they are scrapped and removed. After any capital improvements are made, if an investor has an existing schedule, they should have it updated to include any newly installed items to maximise future claims.
4. Split deductions correctly if you are a couple who co-own
Property owners often purchase a property with a friend or colleague. Many co-owners make the mistake of calculating depreciation and then splitting the deductions based on ownership percentage. However, depreciation legislation allows co-owners to split an asset's value by ownership percentage first, potentially qualifying them for higher rates of depreciation. Ask for a split depreciation schedule to ensure that deductions are outlined based on each owners interest in the assets contained within the investment property.
If you’re preparing your tax return, the most important advice is to seek adequate advice from an expert. Quantity surveyors are recognised by the ATO as one of a few types of professionals with the necessary knowledge to calculate construction costs for depreciation purposes. Alongside your accountant, they can provide guidance to steer you on the right path to ensure your claim is correct and you receive the best possible deductions. Asking these experts will also mean you can rest assured that you’ll have the adequate evidence necessary should the ATO question any of your claims.