Investment tip: 5 ways to avoid common tax mistakes

As an owner of a rental property, they must be able to determine the rental income assessable for tax purposes, the expenses allowable for deductions and the records that needed to be kept, as well as other tax obligations, such as capital gains tax, goods and services tax and negative gearing.

Whether lodging the tax return independently or through a tax agent, investors are strongly advised to do due diligence in order to avoid tax mistakes, which could significantly delay or derail their investment journey.

To avoid the common tax mistakes, experts advise the following:

1. Keep the right records

Investors are advised to keep evidence of their income and expenses so they can claim all that they are entitled to, reduce the risk of tax audits and adjustments and avoid exposure to penalties.

The types of records you should keep, generally for five years from the date of tax return lodgement, include

• Rental payments received
• Expenses related to rental property
• Date of acquisition/disposal of asset
• Gifts, donations and contributions, if any
• Disability aids, attendant care or aged care expenses, if any

Records, which should be in English or readily translatable in English, must include the name of the supplier, amount of the expense, nature of the goods or services, the date when the expense was incurred and the document was made.

Some of the common examples of records to be kept for an easier completion of the tax return are loan documents, receipts for expenses, land tax assessments, credit card records, tenant leases, banks statements and rent records from property managers.

2. Make the property genuinely available for rent

Rental expenses can only be deductible if they are incurred to produce rental income. Thus, unless the property is already rented, investors must be able to demonstrate a clear intention to rent out their property.

Consider collecting evidence that the property has been advertised for rent, keeping the property in good condition to attract renters, setting a realistic rental rate and placing reasonable tenancy conditions to prove the genuine availability of the rental property.

Expenses may still be deductible even if the property is not rented for a particular period as long as the property is proven to be genuinely available for rent.

3. Study deductible costs

Not all expenses can be claimed immediately, so investors are strongly advised to get deductible costs right in order to maximise their entitlements.

Non-immediate deductibles

For instance, initial repairs or improvements cannot be claimed as an immediate deduction in the same income year that the expense was incurred. Moreover, repairs must be directly related to wear and tear or damages caused by having the property rented out.

The cost of repairs done for damages that existed before the property was purchased will be used to work out the profit when the property is sold. For the replacement of an entire structure despite being only partly damaged, the works will be classed as an improvement and are, therefore, not immediately deductible.

Meanwhile, building costs, including extensions, alterations and structural improvements can be claimed as capital works deductions. Generally, capital works deductions can be claimed at 2.5 per cent of the construction costs for 40 years from the date of completion.

Other expenses deductible over a number of income years include borrowing expenses and amounts for the decline in value of depreciating assets.

For borrowing expenses over $100, the deduction will be spread over five years. If less, the full amount can be claimed in the same income year that the expense was incurred.

Immediate deductibles

On the other hand, ongoing repairs that are directly related to wear and tear and other damage caused by renting out the property are classed as a repair and can, therefore, be claimed in full in the same income year that the expense was incurred.

Other expenses for which the investor can claim an immediate deduction are costs for advertising for tenants, bank charges, body corporate fees and charges, cleaning, council rates, electricity and gas, gardening and lawn mowing, in-house audio and video service charges, insurance related to the rental property, interest on loans, land tax, lease document expenses, legal expenses, mortgage discharge expenses, pest control, property agents fees and commissions, quantity surveyor’s fees, temporary tenant relocation (if applicable), repairs and maintenance, secretarial and bookkeeping fees, security patrol fees, servicing costs, for example, servicing a water heater, stationery and postage, telephone calls and rental, tax-related expenses, travel and car expenses and water charges. These must have been paid for by the investor and not the tenant to be deductible.

Some immediate deductibles may be subject to conditions. Experts advise investors to get in touch with ATO or property and finance professionals, where appropriate to maximise their entitlements.

Non-deductible

Finally, if the property is rented out below market rate, the investor can only claim deduction up to the amount of rent they received. No deductions can be claimed for periods of personal use or during a time when the investor let family or friends stay free of charge.

Investors cannot claim deductions for the costs of the property purchase as well, including conveyancing fee and stamp duty. Once the property is sold, the acquisition costs will be used to determine whether the investor is liable for capital gains tax.

Other non-deductible expenses are the costs for the disposal of the property, expenses incurred by tenants such as water and electricity usage, travel expenses and costs of rental seminars before the acquisition of the property and the costs of relocating assets between rental properties prior to renting.

4. Understand the considerations for co-owning property

Declaring rental income and claiming expenses will be different for independent investors and co-owners of rental properties.

In a co-ownership, the income declared and expenses claimed will be based on the legal ownership of the property. Joint tenants will have legal interest split while tenants in common may have different ownership interests, wherein one may hold 20 per cent interest and the other an 80 per cent interest, for example. There can also be a partnership carrying on a rental property business.

Rental income and expenses must be attributed to each co-owner based on their legal interest in the property despite any oral or written agreement that may state otherwise.

5. Understand the implications of selling property, particularly capital gains tax

When investors choose to sell their property, they could make a capital gain or capital loss. Capital gains will need to be included in the tax return, while capital losses may be carried forward and deducted from capital gains in later years.

Capital gains tax is the tax that investors pay on the capital gains or the profit they make after selling or disposing of the property, which is considered part of their income tax.

The tax is applicable to all assets acquired since capital gains tax was implemented on September 20, 1985, with a few exemptions, including principal places of residence and inherited or gifted properties.

Capital gains tax could take up a huge chunk of your budget, which is why experts strongly encourage investors to do due diligence before ultimately selling a property. Take time to calculate your capital gains through different methods in order to get the best rate for your portfolio.

Smart Property Investment CGT calculator allows an estimated calculation of the CGT to be paid based on the sale price of a property minus all expenses associated with acquiring, holding, and disposing of the property.

This information has been sourced from Australian Taxation Office, Commonwealth Bank of Australia and the Smart Property Investment website.