You have to know the tax rules when it comes to property!
And not just rely on your accountant! Investing in rental homes can build wealth. But owners must know the tax rules. These rules cover rental income, deductions, and capital gains. This guide will outline tax issues that rental owners should know. Rules, they often ignore. This ends up costing them large amounts of hard-earned money by missing out of deductions, breaking the law and copping large fines
- Taxes on Rental Income
Rental income must be reported to the tax office. I have come across people that don’t even do this! Live long enough and you’ll see just about anything in the rental realm! This income is taxable each year (“Australian Taxation Office”). Landlords can obviously claim deductions to reduce tax. These deductions include repair costs, fees, and loan interest. Sometimes that throws the whole thing to the negative i.e in the red. The “red” can be used to reduce the tax on salaries and other income sources. So your property grows in value over time, at a discount. That’s what they call negative gearing. More of that below.
For example, a rental home earns $30,000 in one year. The landlord can claim $10,000 in costs. This makes the taxable income $20,000. This income is taxed at the owner’s tax rate.
(As you probably know, from reading my other blog posts, these are not applicable to your situation directly. You need to contact an accountant to make sure you are not going to screw up badly. Do NOT attempt to become your accountant by reading random blog posts like this one. That is a doomed approach. Not because we want more customers. We’ve got plenty as it is.)
- Negative Gearing
Negative gearing is common in Australia. It happens when rental costs are more than rental income. The loss can reduce other taxable income (Real Estate Institute of Australia). This is popular with those in high tax brackets. It can save them a lot on tax.
But it has risks. Negative gearing means the owner loses money each year. This loss could affect cash flow and may lead to debt (“Australian Taxation Office”).
- Deductions for Landlords
Landlords can deduct some costs each year. This can save them money on tax:
Interest on Loans: Interest on loans for rental property is a deduction. Only the loan part used for the rental can be claimed (“Property Council of Australia”).
Depreciation: Depreciation claims are also possible. There are two types: capital works and plant and equipment.
- Capital Works: These are claims for the building itself. Owners of homes built after 1987 can claim 2.5% of the building cost each year. This applies for up to 40 years (McGrath).
- Plant and Equipment: This includes items like carpets and ovens. Items in second-hand homes bought after 2017 cannot be claimed unless replaced with new items (BMT Tax Depreciation).
Repairs and Maintenance: Repairs can be claimed as deductions. But improvements, like adding a room, must be claimed over time. Many landlords mix these up, but the difference matters (“Australian Taxation Office”). This comes in audits regularly. Others mix it up with “replacement costs”. They think if the item is replaced “like-for-like” you can claim anything right away. Not for all things. In general, we found the rule was more palatable to the ATO when items were small-ish.
Management Fees: Fees paid to manage the property are deductible. These fees cover tenant screening, rent, and repair issues.
Council Rates and Utilities: If landlords pay council rates or utilities, these are deductible. But if the tenant pays them, the landlord can’t claim these as a cost (Real Estate Institute of Australia).
- Capital Gains Tax (CGT)
CGT applies when a rental home is sold for profit. The gain is the sale price minus purchase costs, fees, and upgrades. But some CGT exemptions help reduce tax.
Main Residence Exemption: If the property is a main home, the owner can avoid CGT. But if the home was rented out, this exemption may not cover the full gain (“Property Council of Australia”). For example, if a home was half rental and half main home, only half the gain may be exempt.
Partial Exemption: If a home was partly a rental, the owner may get a partial CGT exemption. This depends on how long it was rented out. The ATO may reduce CGT based on this rental time (McGrath).
CGT Discount: If the property was owned for more than a year, a 50% CGT discount applies. This means only half of the gain is taxable (BMT Tax Depreciation). For example, if the gain was $100,000, only $50,000 would be taxed.
There are other things like the 6 year rule and so on. CGT is complex & will be dealt with in more detail over the next 100 blog posts or so! And I am only slightly joking!
- Goods and Services Tax (GST)
GST does not apply to rent or the sale of used homes. But GST can apply to some property sales, like new homes sold by developers. Owners should check with a tax expert to see if GST applies (“Australian Taxation Office”).
- Record-Keeping and Compliance
Good record-keeping is key for landlords. The ATO requires landlords to keep records of all rental income and costs for five years. Landlords should store all receipts, contracts, and statements.
Depreciation Schedules: A depreciation schedule by a quantity surveyor can help maximize deductions. This schedule lists all assets and their value. This makes it easy for owners to claim each item’s value (BMT Tax Depreciation).
Rental Period Records: If the home is rented out part-time, owners need to track rental times. Only costs from rental times are deductible. Keeping good records ensures correct tax reporting.
- Avoiding Common Tax Mistakes
Landlords often make errors in tax reporting. These mistakes can lead to lost money or ATO penalties.
- Claiming Personal Costs: Only costs linked to the rental can be claimed. Personal expenses, like home repairs done for private use, cannot be deducted.
- Depreciating Land Value: Land does not lose value. Only the building and assets within can be depreciated. Trying to depreciate land could lead to problems with the ATO.
- Ignoring Plant and Equipment Rules: Since 2017, plant and equipment in second-hand homes cannot be depreciated unless new. Landlords should check rules for these assets. Use a quantity surveyor if in doubt. Your accountant is likely to not know the value/price of different things in the rental.
- Mixing Up Repairs and Improvements: Repairs can be claimed right away. But improvements must be claimed over years. Landlords often claim improvements as repairs. This can lead to ATO audits.
- Getting Professional Help
Property tax rules are complex. An accountant or tax adviser can help landlords make the right claims. A quantity surveyor can help by creating a depreciation schedule. This can help landlords claim all deductions they deserve (McGrath). For the rest, talk to us, your accounting ninjas!
Works Cited
Australian Taxation Office. “Rental Properties 2023.” Australian Taxation Office, 2023, www.ato.gov.au/General/Property/Rental-properties.
BMT Tax Depreciation. “Residential Property Depreciation.” BMT Tax Depreciation, 2023, www.bmtqs.com.au/residential-property-depreciation.
McGrath, John. “Understanding Capital Gains Tax (CGT) on Residential Properties.” McGrath Estate Agents, 2023, www.mcgrath.com.au/advice/articles/capital-gains-tax.
Property Council of Australia. “Capital Gains Tax and Property.” Property Council of Australia, 2023, www.propertycouncil.com.au/advocacy/cgt.
Real Estate Institute of Australia. “Negative Gearing and Its Impact on Property Investment.” Real Estate Institute of Australia, 2023, www.reia.com.au/negative-gearing/.