Why property buyers need to know about tax deductions

Everyday Australians could be throwing away the opportunity to purchase an investment property, with new data revealing three out of five people aren’t aware of one of the most lucrative tax deductions investors use to help make a purchase affordable.

According to a recent survey by online lender State Custodians, 61 per cent of respondents don’t know that mortgage interest payments on an investment property are tax deductible.

Interest is usually the biggest expense of owning an investment property. Fortunately for investors, it’s a cost that can be deducted from rental income – along with a variety of other expenses – to minimise tax obligations. 

The data suggests most people are bamboozled by the intricacies of investing, and as a result, it ends up in the too-hard basket.

By failing to understand the incentives on offer, including negative gearing, would-be investors – and especially young people desperate to get on the property ladder – might be locking themselves out of the market, as deductions can affect whether purchasing an investment property is feasible. 

State Custodians general manager Joanna Pretty says a poor understanding of tax allowances could be a significant barrier preventing ordinary people from investing in property.

“There are a lot of people who don’t realise how achievable it is,” she says. “The whole prospect seems daunting. You feel like you need to have a level of experience that you actually don’t need to have.”

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A property is said to be negatively geared when expenses exceed rental income, and this net loss can be applied against other income, including salary or business income, to reduce your tax bill.

This means that if the rent doesn’t cover the interest, management and maintenance costs, the difference is deductible, effectively giving investors a discount off the loss at their marginal tax rate.

The goal for investors should be an increase in the capital value of the property, and ideally this outweighs any loss incurred, allowing the owner to generate equity and increase their wealth. 



A capital works deduction is the cherry on top. This incentive allows investors to claim 2.5 per cent of the construction costs of the building each year if the property was built after 1985.

Construction costs are spread over 40 years, which is what the ATO considers the effective life of the building. Even though an investor didn’t directly pay for the construction out of their pocket, they can claim a fraction of the costs for each year the property is used to generate rental income, as the diminishing value of the building is considered part of the purchase price. 

Investors are often surprised to learn they can use this method to deduct several thousands of dollars per year from their taxable income. Alterations costs, such as a bathroom renovation, can also be claimed if works commenced after 1992. The research revealed two thirds of people don’t know about this lucrative incentive.



Property Tax Specialists principal adviser Shukri Barbara is surprised by how few people knew about common tax deductions given negative gearing is such a hot-button political issue, but says most serious property investors are well aware of tax minimisation strategies. 

“For most of the people who want to invest in property, the major selling point is the interest deduction,” he says.



Gen Y in the dark about deductions

The research also reveals younger people are twice as likely to be unaware of common tax deductions as older generations.

Only 23 per cent of people under 35 know interest repayments are tax deductible compared with 44 percent of people aged 35 and over.

Pretty says this is especially surprising given Gen Y’s eagerness to get into the market, but suggested the high cost of housing could be putting people off investing as they feared a negative impact on their lifestyle.

“They think it’s more expensive in terms of their normal living expenses than it actually is,” she says.

According to Barbara, expensive house prices have caused young people to become less engaged in researching investing. “Gen Y has been slow getting into the market because of rising prices over the past seven years, and as such their interest and attention hasn’t really been drawn to these sort of affairs.”

Pretty suggests understanding the tax system can help young people get a leg on the property ladder without having to make major lifestyle changes.

“That traditional plan of buying a place in the area you want to live in and staying there for 40 years is perhaps not as relevant any more. Rentvesting is actually a very good way for people to get ahead in these very expensive metro environments.”

By using their available savings as a deposit for an affordable investment property, young home buyers can grow their wealth faster than through saving alone, and eventually use the equity to help fund an owner-occupier purchase.

The tax deductions all investors need to know about

The Australian Tax Office explains what expenses are deductible, but crunching the numbers based on a hypothetical property purchase can help put it into perspective.

According to the ATO, these are some of the expenses that may be deducted immediately:

• Interest expenses.
•  Real estate agent fees and commission.
•  Repairs and maintenance.
•  Advertising for tenants.
•  Body corporate fees and charges.
•  Council rates and water charges.
•  Land tax.
•  Cleaning and pest control.
•  Gardening and lawn mowing.
•  Building, contents and public liability insurance.
•  Some legal expenses.

Other expenses can still be claimed, but over a longer period of time:

•  Borrowing expenses, such as loan establishment fees and lenders mortgage insurance.
•  Depreciation of new assets, such as appliances, carpet and furniture.
•  Capital works, including building costs, renovations or additions.