It’s no secret that Property Investment is a great vehicle to minimise tax and give yourself greater financial freedom.
While the Australian Taxation Office (ATO) considers rental income as a taxable income, investors can claim a number of expenses to reduce this amount – including but not limited to: Property Management fees, maintenance and repairs, depreciation, insurances and much much more.
However, while this poses great benefits for investors, there is still a risk of making several mistakes along the way. In this article, we explain some of the common mistakes investors have when filing their tax returns – and most importantly, how you can avoid them!
Mistake 1: Differentiating A Repair From An Improvement
As a landlord, it is inevitable that at one stage or another, you will run into damages in your property. As the cost of repairs due to damage is usually an immediate tax deduction, this is only the case if you fulfil the criteria for a repair, being: to restore the damaged feature back to its original working condition. Not an improvement or enhancement.
Take bathroom tiles as an example. Let’s say your tenant cracks one of the tiles which requires replacing. In order to claim this as a tax deduction, you will need to replace it with the same, if not, very similar kind of time. If you go out and purchase tiles of a higher quality, this would be deemed an improvement.
The reason we highlight this is because an improvement can increase the value or appeal of a property, which does not make it an immediate tax write off.
In this circumstance, you would look to make a claim on depreciation about certain features within the property.
Mistake 2: Not Taking The Time To Understand How Capital Gains Tax (CGT) Works
If you sell your investment property within 12 months of owning it, you are required to pay CGT on the profit of that sale.
In Australia, capital gains are taxed at the same rate as taxable income. For example,if you earn $40,000 (32.5% tax bracket) per year and make a capital gain of $60,000, you will pay income tax for $100,000 (37% income tax) and your capital gains will be taxed at 37%.
However, if you own the investment property for more than 12 months before selling, you are eligible for a 50% discount on your CGT which means you will only need to include half of the capital gain in your tax return.
For instance, If you enter a contract to sell in April 2021 and settle in May 2022, your capital gain or loss must be reported in your 2021-2022 tax return.
It is based on when you enter the contract to sell, rather than when settlement occurs.
While there are some exceptions, CGT should be paid after the sale on all investment properties. This does not apply for owner-occupied properties. The only reason you wouldn’t have to pay CGT is if you make a capital loss. One advantage here is that this loss can be used to offset future capital gains, but not any other type of tax.
Mistake 3: Claiming Interest On A Loan Not Solely Used For Your Investment Property
As a property investor, one of the main advantages you will receive is that if you acquire a home loan to pay for the investment property, the interest on this loan is a tax deduction.
Having said that, if any funds from the loan is used for expenses unassociated with the property in question, you cannot claim interest on that portion of the loan. For example, if you leverage your redraw facility to purchase a new family car, you will not be permitted to claim interest on this amount.
Mistake 4: Ensuring your Property Is Genuinely Available for Rent
If your property is not available for rent for a portion of the financial year, the expenses you incur on the property during that period will need to be divided and determined accordingly. This amount is often not taken into account in the tax return, which can create risks should the ATO decide to review the claims.
The key here is to determine whether the property is not available for rent, versus a property being left vacant but is available to rent.
The latter outlined above does not allow you to claim expenses as it is still available to rent – meaning that the sole purpose of the property is to produce an income, despite the fact it has not been rented/leased.
To understand whether an untenanted property was available for rent, the ATO will look to see whether the property was actively marketed to prospective tenants. Therefore, proof of marketing/advertising agreements with Real Estate agents will be of great use.
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