In 2021 Tax Tips

Investing in an investment property is a great way to grow your wealth. However, if you’re not careful with the tax obligations surrounding this type of purchase, it can end up costing more than expected. 

In this blog post, we’ll go over some basic tax-smart tips for your investment property that will help you save on taxes and make your investments as profitable as possible.

We are selling an investment property or main residence

If you sell an investment property or the main residence that you have rented out, remember:

  • You may have to pay capital gains tax, even if you transfer the property into someone else’s name.
  • A capital gain is a difference between your cost base (cost of ownership) and your capital proceeds (what you receive when you sell the property or the market value when you transfer the property).
  • If your costs of ownership are greater than your capital proceeds, a capital loss should be included in your return, and this amount may reduce future capital gains.
  • Your cost base should not include these amounts if you have claimed a deduction for capital works or depreciation in any income year.
  • If you have owned the property for more than 12 months and are an Australian resident, you may be entitled to a 50% discount on tax on the capital gain.

Simple steps when preparing your return

Rental property owners should remember three simple steps when preparing their return.

1. Include all the income you receive

This includes:  

  • short term rental arrangements (for example, a holiday home)
  • sharing part of your home
  • other rental-related income such as insurance payouts and rental bond money you retain.

2. Get your expenses right

  • Eligibility – Claim only for expenses incurred for the period your property was rented or when you were actively trying to rent the property on commercial terms.
  • Timing – Some expenses must be claimed over several years.
  • Apportionment – Apportion your claim where your property was rented out for part of the year, or only part of your property was rented out, where you used the property yourself or rented at below-market rates. You must also apportion in line with your ownership interest.

3. Keep records to prove it all

You should keep records of both income and expenses relating to your rental property, as well as purchase and sale records.

Record keeping tips

Set up an easy-to-use record-keeping system as your priority. This can be as simple as a spreadsheet, or you can use professional software.

Keep records of every transaction over the period you own the property. This includes contracts of purchase and sale, as well as conveyancing and loan documents.

Scan copies of your receipts to make them easier to store and access.

Remember – keeping proof of all your income, expenses and efforts to rent out your property means you can claim everything you are entitled to.

Getting record-keeping right makes tax time easy.

Whether you use a tax agent to prepare your tax return or do it yourself, you need to keep proper records over the period you own the property.

Keep good records at each stage of your journey to ensure you can claim everything you’re entitled to, such as:

Buying

  • Contract of purchase
  • Conveyancing documents
  • Loan documents
  • Costs to buy the property
  • Borrowing expenses

Owning

  • Proof of earned rental income
  • All your expenses
  • Periods of private use by you or your friends
  • Periods the property is used as your main residence
  • Loan documents if you refinance your property
  • Efforts to rent the property out
  • Capital improvements

Selling

  • Contract of sale
  • Conveyancing documents
  • Sale of property fees
  • Calculation of capital gain or loss

Work out your capital works deductions

You can claim capital works deductions for certain construction costs for a rental property. However, your capital works deductions can’t exceed the construction expenses.

The percentage of deduction, and the number of years you claim it for, are determined by the type of construction, and the date construction commenced.

Limits to claiming capital works deductions

filling-out-papers

You can only claim a deduction for those periods during the year you used your rental property for income-producing purposes. You can’t claim for the period you use the property for personal purposes.

Example: how to work out capital works deductions from the date construction starts

On 1 March 2020, Meg purchased a rental property for $300,000 and immediately rented it out. Meg obtained a report from a quantity surveyor stating:

Construction of the property commenced in February 2003.

The property is a residential townhouse.

Construction was completed in November 2003.

A developer built the townhouse.

The estimated cost of constructing the townhouse was $200,000.

Meg claims a capital works deduction in her 2020 tax return for her rental property based on the estimate of the construction costs she gets from the quantity surveyor. However, she only claims a deduction for that part of the year her property was available for rent (1 March to 30 June 2020). The rate of deduction she claims was 2.5% as construction of her residential property started after 15 September 1987.

Her annual capital works deduction was calculated as follows:

$200,000 × 2.5% (see note)=$5,000

Note: See the date construction commenced for different rates of reduction.

As the property was only used for income-producing purposes for 122 days in 2020, her 2019–20 claim was calculated as follows:

$5,000 × (122 ÷ 366) = $1,667

End of example

What you need to know to work out your claim

As a general rule, you can claim a capital works deduction for the construction cost for 40 years from the date the construction was completed. 

However, to make sure that you are eligible, you must have all of the following:

Capital works expenses you incur form part of the cost base of your property for capital gains tax purposes. Therefore, if you claim a capital works deduction, you will need to consider this when you work out your capital gain or loss.

If it isn’t possible to determine the actual construction costs, you can obtain an estimate from a quantity surveyor or other independent qualified person. You can claim a deduction for the fees you pay to obtain this estimate.

For information about how capital works deductions affect the CGT cost base, see Cost base adjustments for capital works deductions.

Types of construction and the date construction commenced

To be eligible to claim a capital works deduction, construction work must commence after the data relevant to that type of construction is in the table below.

The amount you can claim for construction expenses depends on the type of construction and the date you start construction. This table shows the deduction rate and the period over which you can claim the deduction depending on the type of construction.

Construction cost

You must provide evidence of the construction costs by either of the following:

  • precise documents that show the construction costs such as receipts
  • an appropriately qualified person wrote a report.

The following items can’t be used as the construction cost:

  • the purchase price of the building and land
  • the insured cost
  • the replacement cost.

If you were the owner-builder

If you carried out the construction as an owner-builder, the value of your contribution to the works does not form part of the construction cost. This includes:

  • your labour and expertise
  • any notional profit element – that is, an amount you might consider as a profit margin on the construction cost.

Obtaining the construction information

You should make sure you keep records that detail the construction costs, whether:

  • you carry out the construction
  • you contract a builder to carry out the construction.

Suppose you don’t record the construction costs (for example, where the vendor did not provide them). In that case, you will need to obtain this information from either the previous owner or an appropriately qualified person. This could be a:

  • quantity surveyor
  • clerk of works, such as a project organiser for major building projects
  • the supervising architect who approves payments at project stages
  • builder with experience estimating construction costs of similar building projects.

You can claim a deduction for your costs of obtaining this information from an appropriately qualified person in the income year you pay it.

Quantity surveyor reports can also include a schedule of depreciable assets (capital allowances). 

You can claim a separate deduction for the decline in value of depreciating assets in a rental property:

  • if you bought the rental property before 7.30 pm (AEST) on 9 May 2017 – it doesn’t matter whether the property was brand new or not
  • if the depreciating asset is brand new – purchased at or after 7.30 pm (AEST) on 9 May 2017
    • as part of your brand new property
    • that you subsequently bought for your existing (non-new) property
  • if you bought the property on or after 7.30 pm (AEST) on 9 May 2017 to provide residential accommodation, the property has to be brand new or substantially renovated if no one previously claimed any depreciation deductions on the asset, and
    • either no one lived in the property when you acquired it, or
    • if anyone lived in the property after it was built or renovated, you acquired it within six months of the property being built or renovated
  • the property does not provide residential accommodation, or
  • the asset is used in carrying on a business, or
  • the entity claiming depreciation is a:
    • corporate tax entity
    • superannuation plan other than a self-managed superannuation fund
    • public unit trust
    • managed investment trust
    • unit trust or partnership whose members are any of the entities in this dot-point.

You should provide the buyer with capital works notice containing information to allow them to work out their capital works deduction if you both:

  • are a vendor disposing of capital works begun after 26 February 1992
  • were able to claim a deduction for those capital works.

The notice should be provided within six months following the income year that you dispose of the property or a further period allowed by us.

Where you don’t use the property to gain rental income, the vendor disposing of the property doesn’t need to provide the purchaser with notice. In this situation, the purchaser can obtain an estimate, usually from an appropriately qualified person.

Remember to obtain your construction costs report as soon as possible, as these reports can take a long time to prepare. If you obtain a report after you lodge your tax return, you can amend your tax return by a certain later date. However, there is a time limit on amending tax returns for which we have already issued a notice of assessment.

Top 10 tips to help rental property owners avoid common tax mistakes

Whether you use a tax agent or choose to lodge your tax return yourself, avoiding these ten common mistakes will save you time and money.

Apportioning expenses and income for co-owned properties

If you own a rental property with someone else, you must declare your rental income and claim expenses according to your legal ownership of the property. As joint tenants, your legal interest will be an equal split, and as tenants in common, you may have different ownership interests.

Make sure your property is genuinely available for rent

Your property must be genuinely available for rent to claim a tax deduction. This means:

  • you must be able to show a clear intention to rent the property
  • advertising the property so that someone is likely to rent it and set the rent in line with similar properties in the area
  • avoiding unreasonable rental conditions.

Getting initial repairs and capital improvements right

paperwork

Ongoing repairs that relate directly to wear and tear or other damage that happened due to you renting out the property can be claimed in full in the same income year you incurred the expense. For example, repairing the hot water system or part of a damaged roof can be deducted immediately.

Initial repairs for damage that existed when the property was purchased, such as replacing broken light fittings and repairing damaged floorboards, aren’t immediately deductible. Still, a deduction may be claimed over several years as a capital works deduction. When you sell the property, these costs are also used to work out your capital gain or a capital loss.

Replacing an entire structure like a roof when only part of it is damaged or renovating a bathroom is classified as an improvement and not immediately deductible. However, these are building costs which you can claim at 2.5% each year for 40 years from the date of completion.

Suppose you completely replace a detachable damaged item from the house and it costs more than $300 (for example, replacing the entire hot water system). In that case, the cost must be depreciated over several years.

Claiming borrowing expenses

If your borrowing expenses are over $100, the deduction is spread over five years. If they are $100 or less, you can claim the full amount in the same income year you incurred the expense. Borrowing expenses include loan establishment fees, title search fees and costs of preparing and filing mortgage documents.

Claiming purchase costs

You can’t claim any deductions for the costs of buying your property. These include conveyancing fees and stamp duty (for properties outside of the ACT). However, if you sell your property, these costs are then used to determine whether you need to pay capital gains tax.

Claiming interest on your loan

You can claim interest as a deduction if you take out a loan for your rental property. However, if you use some of the loan money for personal use, such as buying a boat or going on a holiday, you can’t claim the interest on that part of the loan. You can only claim the part of the interest that relates to the rental property.

Getting construction costs right

As capital works deductions, you can claim certain building costs, including extensions, alterations, and structural improvements. As a general rule, you can claim a capital works deduction at 2.5% of the construction cost for 40 years from when the construction was completed.

Where your property was previously owned by someone else and claimed capital works deductions, ask them to provide you with the details so you can correctly calculate the deduction you’re entitled to claim. If you can’t obtain those details from the previous owner, you can use the services of a qualified professional who can estimate previous construction costs.

Claiming the right portion of your expenses

If your rental property is rented out to family or friends below market rate, you can only claim a deduction for that period up to the amount of rent you received. In addition, you can’t claim deductions when your family or friends stay free of charge or for periods of personal use.

Keeping the right records

You must have evidence of your income and expenses so you can claim everything you are entitled to. Capital gains tax may apply when you sell your rental property. So keep records over the period you own the property and for five years from the date you sell the property.

Getting your capital gains right when selling

When you sell your rental property, you will make either a capital gain or a capital loss. Generally, this is the difference between what it cost you to buy and improve the property and what you receive when you sell it. 

Your costs must not include amounts already claimed as a deduction against rental income earned from the property, including depreciation and capital works. If you make a capital gain, you must include the gain in your tax return for that income year. You can carry the loss forward and deduct it from capital gains in later years if you make a capital loss.

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