Important tax tips for property investors

While property investors are privy to a range of specialised tax breaks, they are also subject to taxes most non-investor homeowners aren’t, including capital gains tax (CGT) and land tax.

To help property investors gain a better understanding of their taxation obligations we spoke with Paul Drum, Head of Policy at CPA Australia, about allowable tax deductions, CGT and investing in property via a self-managed superannuation fund (SMSF).

Q. How can property investors maximise their deductions?

A. Property investors can claim a wide range of deductions in respect of a rental property if they retain the appropriate documentation and invoices.

Some of the more common expenses you may be able to claim in relation to the investment property include:

• Advertising for tenants
• Cleaning costs
• Council and water rates
• Electricity and gas
• Gardening costs
• Insurance (building, contents, etc.)
• Interest on the investment loan
• Land tax
• Real estate management fees
• Repairs and maintenance
• Reasonable travel expenses (for inspection of property).

The cost of items such as white goods, furniture and air conditioners can also be claimed but will be subject to depreciation. This means that the relevant deductions have to be claimed over a period of years based on the useful life of the item in question.

Q. What about building, construction and borrowing costs?

A. Building and construction expenses are not deductible but can be claimed under the special building write-off rules. Broadly, if the rental property was built after 15 September 1987, you can claim the portion of construction expenses that remained unclaimed at the date you acquired the property.

This cost can be written off at 2.5 per cent each year over 40 years. But you have to know the value of the construction work and when it was carried out. You can ask the previous owner to supply the costs, or engage a suitably qualified expert, such as a quantity surveyor, to provide an estimate. In the case of a new dwelling, the builder or a quantity surveyor should be able to provide you with the relevant cost details.

Borrowing expenses such as loan procurement fees are also allowable tax deductions but are generally claimed over five years.

Q. What is not deductible?

A. Some outgoings are not deductible but can form part of the cost base of a property if subsequently sold, for capital gains tax purposes.

Along with the original purchase price, some items you may wish to include in the cost base are set out below:

• Stamp duty on purchase
• Valuer’s fees on acquisition
• Legal expenses which are incurred on the purchase and sale of the property
• Advertising costs on sale
• Auctioneer’s fee
• Capital expenditure on improvements that increase or preserve the asset’s value (e.g. building a new garage).

Q. Any tips on deductions for property investors?

A. You may wish to consider an interest-only loan on your rental property as such a loan ensures interest expenses remain high without reducing the principal of the loan. This can work in your favour when negatively gearing as it will help offset your overall taxable income. However, the decision to enter an interest-only loan should be driven by your financial circumstances now and into the future.

If you need to travel to your rental property for management purposes you may be able to claim travel expenses incurred while inspecting the property. This will usually be restricted to the costs involved in, say, flying to the property one day and back the next. If you fly to the property and then take two weeks holiday, the Australian Taxation Office (ATO) will require that you apportion the expenses between those that can be claimed and non-deductible private expenses.

Q. When would an investment property not be subject to CGT?

A. It’s useful to bear in mind that an investment property that was previously your main residence (the family home) can continue to be treated as a main residence (and thus retain its CGT-exempt status) for up to six years after the dwelling stopped being the main residence, provided you don’t have any other main residence.

Q. What happens if the sale of an investment property is subject to CGT?

A. You may be liable to pay CGT on the sale of arental property if that property was acquired on or after 19 September 1985.

You will derive a capital gain from the sale of the property when the sale proceeds are more than the property’s cost base; and a capital loss if the sale proceeds are less than the cost base.

If you realise a capital gain on such an investment property, it is first necessary to apply any capital losses from the current or prior year. Any remaining net capital gain can be potentially further reduced by applying the 50 per cent capital gains tax (CGT) discount for taxpayers who have owned their property for more than 12 months. However, if you have held the property for less than 12 months, the 50 per cent CGT discount is not applicable and therefore the full net gain is taxed as income.

Given that you may often be liable to pay tax on the sale of a rental property, it is suggested that you put aside part of the proceeds of the sale to help pay a potentially large tax bill.

Q. Is the cost base of the property affected by building depreciation claims?

A. If capital works deductions have been claimed in respect of a rental property, then such deductions may reduce the cost base of the property for capital gains tax purposes. Special rules apply in the case of any depreciable buildings sold with the property.

Q. What are the rules for investing in property via an SMSF?

A. A person should not choose to establish an SMSF simply because they want to invest in property and without proper consideration of all the risks, benefits and associated costs involved.

The high cost of property may mean that the SMSF is heavily weighted in one asset class, and trustees are obliged to consider diversification as part of their investment strategy within the SMSF. Diversification helps to limit investment risk if any one asset class underperforms.

Purchasing property via an SMSF has a number of tax advantages. Foremost is a maximum tax rate of 15 per cent on net rental income while the SMSF is in accumulation mode and 0 per cent when in full pension mode. Further, where the property is sold after being held for more than 12 months, any resulting capital gain will incur a maximum 10 per cent capital gains tax rate or 0 per cent if in pension mode.

Conversely, any deductions for losses or outgoings for a rental property bought via an SMSF will be limited to a maximum of 15 per cent.

For most clients, it may in fact be more tax-effective to purchase the proposed rental property in other structures or under their own name instead of via a SMSF.

Q.  What common taxation pitfalls should investors look out for?

A. Investors often bundle a mix of properties under a single loan umbrella. For example, their home and a rental property might be funded via the same mortgage. In these circumstances, it is important to make sure you structure your loan so that it is easy for you (and the ATO in case you are audited) to identify what portion of the loan is related to the rental property. You can then work out what proportion of the interest can be claimed as an expense against your rental income.

It is important to note that you cannot claim a deduction for interest you pay or for any other expense you incur after the property is no longer rented or available for rent, or the portion of the loan you use for private purposes.

Make sure you identify all eligible costs to be included in the cost base of the asset, as it may both reduce any capital gain and increase any capital loss which can be carried forward indefinitely to apply against any future capital gains.

This information is a guide only. For further information on your tax obligations for owning a rental property, see your CPA-registered tax agent or download the ATO guide for rental property owners at www.ato.gov.au.