Tax Deductions While Building an Investment Property

investment property tax deductions example

Rental Property Expenses That You Can Claim Now

Generally, property owners can claim an immediate or one-time deduction against their income for the current year for the costs they incurred in managing and maintaining their rental properties, which includes loan’s interest.

Real estate owners or landlords can get the rental property tax deductions of the entire amount of their leased expenses against their profits and other income receivables, like business income, salary, and wages, among many others when their leasing properties are in negative gearing.

Expenses That You Can Claim Within the Year

Property owners can only claim the costs of the expenses spent on their respective rental properties only when they incur the fees and when tenants don’t pay for them.

These are the standard information that you need to know for your future tax deductions while building an investment property.

Expenses that landlords or owners are authorized to claim for an immediate deduction within the income year incurred include the following list:

  • Water charges
  • Repairs and maintenance
  • Property agent’s fees and commission
  • Pest Control
  • Pre-paid expenses
  • Legal expenses
  • Land tax
  • Interest costs
  • Insurance ( public liability, building, and contents, among others)
  • Gardening and lawn mowing
  • Council rates
  • Cleaning
  • Body corporate fees and charges
  • Advertising costs for tenant hunting

Interest Costs

An investment property tax deductions example is the interest costs deduction. It means that a landlord can claim for a rebate or cutback of the interest charged to an applied loan for real estate property purchase. Nevertheless, the said property should get rented or legitimately available for renting within the income year when claiming a deduction.

What Are You Eligible to Claim?

So, you might be wondering about what you are eligible to claim. Practically, you can claim for the interest charged on the property loan you used for the following reasons:

  • Buying a rental real estate property
  • A property owner can claim a deduction of the cost he or she paid in buying a rental real estate property.
  • Financing rental property renovations
  • These are the real properties that are available for leasing or presently occupied by tenants. Rental property renovations may include modifications or adding structures and designs to current styles, such as adding a patio or veranda to the rear end of the real estate.
  • Making repairs to the actively rented property
  • You can also get deductions of the costs you spent in conducting repairs to the actively rented or leased real estate property, like repairing a damaged roof caused by the storm.
  • Purchasing an asset that has a depreciating value
  • Buying items or assets that will depreciate in time, such as air conditioners, gas stoves, and many others for the rental property, are also eligible for deduction claims.

Pre-paid expenses of up to one year or twelve months in advance are also qualified to claim the deduction of interest.

What Are You Not Qualified to Claim?

While you can claim for deductions on particular expenses for actively rented properties, there are also interest costs that you are not entitled to a rebate or cutback.

Here is a list of some of these expenses:

  • Buying a new home for personal usage
  • When you apply for a property loan to buy a new home, you are not eligible to get a deduction for the interest that you will incur. If the sole purpose of buying doesn’t include generating an income, you are not qualified for the claim. So, when you purchase a real estate property for personal use, regardless of using the rental property for the loan security, you will not be able to apply for the claim.
  • Using the property for private purposes
  • At any given time or even if it is only for a short period of time, real estate properties used for private purposes are not eligible for the deduction claim.
  • Any portion of the loan interest used for private purposes
  • You can’t also request for a claim on loan interests that you used a portion of it in financing or buying a new car and other personal purposes.

Even if you are ahead of the repayments of your loan, as long as you are using it for personal purposes or for other purposes that don’t generate an income, you will not qualify for the deduction claim.

So, if you have a loan that you used to buy a rental property and for another purpose or item, like purchasing a car, you will have to repay the total loan amount and interest incurred for both purposes, and you will not be eligible for a deduction claim.

  • Say for an instance:
  • Claiming rental property deductions ATO (Australian Taxation Office) for all loan interest incurred

When a couple or two friends draw an investment loan amounting to $350,000 to buy an apartment as joint tenants, and they have it rented for the entire year from the first of July, they will incur an interest charge of $30,000 for the said year.

Therefore, each of the couple or two friends can make a claim for the interest deductions of $15,000 on their corresponding tax returns for the year the property got rented.

  • Claiming deductions for part of the loan interest incurred

Edward pulls out a $400,000 loan. $380,000 of that loan, he used it to purchase a rental property and the remaining money, he used it to get a new car.

The rental property that Edward purchased got rented for the entire year from the first of July. His total interest expense for the entire amount he loaned is $35,000.

Working out on how much interest he can claim as part of his tax deductions, Edward needs to do the calculation, using the investment property tax deductions calculator or the formula illustrated below:

Formula:

A x B = C

Let:

 

A – Total interest expenses

B – (Rental Property Loan/Total Borrowed Amount)

C – Deductible interest

So:

A – $35, 0000

B – ($380,000 ÷ $400,000)

 

Get:

B = 0.95

Therefore:

$35,000 x 0.95 = $33,250

Deductible interest:

C = $33,250

From the above result, Edward can claim $33, 250 as the allowable tax deduction from the portion of the total loan interest he drew.

Calculating interest rates for loans used for both rental and private expenses

Individuals who drew loans to use for both rental and private costs should maintain accurate and tangible records to correctly compute the interest portion of the rental property expenses of the loan, especially if there’s a varying balance due to withdrawals and deposits made.

The interest rate of rental property and private use should be separated.

  • For example:
  • Mortgage interest incurred for a new home

Sam and Lyn pull out a total of $400,000 loan secured towards their existing property to buy a brand-new home. Instead of selling their previous home, they decided to have it rented out.

Bearing in mind that they have a $25,000 worth of remaining mortgage for their existing property that gets added to their $400,000 new loan, subjected to a loan facility with secondary or sub-accounts, which means that the two loans ($25,000 remaining mortgage and $400,000 new loan) are individually managed, but under the existing property security.

Given the data, Sam and Lyn can make a claim for the interest deduction against their $25,000 remaining mortgage loan from their existing home, as they have it rented. Moreover, they can’t get an interest deduction claim on their new $400,000 loan, as they used it to buy a brand-new home that will not generate an income, even if the security of the loan is from their existing home.

  • Fund redrawn interest incurred midway of the year from the loan

When you have an investment loan for your rental property that comes with a redraw facility, you can pull it out again midway of the year. So, when you are ahead of your payments by $9,500, you can redraw or draw it out again in the middle of the year to purchase a lounge suite or new appliance, whatever you may want to buy.

At the time of redraw, the loan balance is $365,000 with $9, 300 total interest expense, and $19,000 is the total interest incurred for the year.

Taking into considerations that the interest expense you can claim is only the portion of the loan applied or connected to your rental property, you can calculate the loan portion of the rental property using the formula provided below.

Formula:

X- Y = Z

 

Let:

X – Total loan balance

Y – Redraw Amount

Z – Rental property loan portion

So:

X = $365, 000

Y = $ 9,500

Get:

$365,000 – $ 9, 500 = Z (Rental property loan portion)

Therefore:

Z = $355, 500

Computing for the interest deduction he can claim, follow the formula given below:

Formula:

A x B = C

Let:

 

A – Total interest expenses

B – (Rental property loan portion/loan balance during the redraw)

C – Deductible interest

 

So:

A = $ 9, 700

B = ($355,500 ÷ $365,000)

 

Get:

B = 0.97260273972

Therefore:

$9,700 x 0.97260273972 = $ 9, 448

 

Deductible interest:

C = $ 9, 448

Overall, you can claim for the interest deduction of $ 18, 748, which is the result of adding the current interest rate at the time of the redraw, $9, 300 plus the deductible interest rate result above, $9,448.

The rules for thin capitalisation

The rules for thin capitalisation will apply under the following circumstances:

  • Australian residents or associates who have particular transactions internationally and overseas interest
  • Foreign residents
  • Debt deductions (your interest plus the interest earned by your associates) of over $2 million from 2017 to 2018.

Pre-paid expenses

Pre-paid expenses include insurance premiums or those that offer services going beyond the current income year. Under these expenses, you can claim a one-time deduction in the same year for the following costs:

  • Pre-paid expenses of $1000 ore above that covers a 12-month or less service period, like the annual premium payment for an insurance part way through an income year.
  • Expenses of less than a thousand dollar

Pre-paid expenses that do not meet the criteria stated above may need to get spread to over a couple of years or more.

Repairs and maintenance

Property owners can claim a full deduction for the repairs and maintenance costs within the year that they incur them under the conditions listed below.

  • When the repairs and maintenance expense directly applies to the wear and tear of the rental property or assets in it, which is the result after having it rented out.
  • The costs apply to a continuously rented out property.
  • Expenses of repair and maintenance involved in an unoccupied rental property due to cancellations caused by inevitable weather problems and unsuccessful advertising campaign for attracting tenants but remains available for occupancy or leasing.

What Deductions Can You Immediately Claim?

  • Repairs

Working out to fix defects, damages, or deteriorations related to wear and tear that resulted in renting out the property.

  • Inclusions of repairs
  • Replacing a damaged fence due to a falling tree branch
  • Fixing or changing a broken window
  • Repairing defective machinery or electrical appliances
  • Mending damaged building gutter
  • Maintenance

Preventing wear and tear or fixing existing defects or deterioration is part of maintenance services required in a rental property to maintain its liveable condition.

  • Inclusions of maintenance
  • Plumbing services
  • Repaint faded walls
  • Fix damaged interior walls and other parts of a rental property
  • Cleaning spaces and other areas
  • Oiling or brushing

What Deductions Can You Claim For More Than Several Years?

  • Unrelated wear and tear repairs and maintenance

If the repair and maintenance made are not connected to wear and tear or damage caused by renting out the property, you can’t claim an immediate or one-time deduction. However, you can get the claim for more than several years with the capital expenses you spent to do so.

This rule also applies to the decline or depreciation in the value of the property or assets within.

  • Property improvements

Improvements or developments made to your rental property are not eligible for a one-time deduction claim in the year you paid them.

When you say improvements, you are referring to anything that will make your rental property even better, nicer, more desirable, more valuable, and more appealing.

Real estate improvements include changes in the features or characteristics of the item in a rental property.

Renovations in rental property spaces, such as decorating or remodelling your current design, are part of capital improvements, which you can claim for deductions under capital works.

  • What does an improvement in rental property mean?
  • Goes beyond the restoration of the effective functioning of the rental property
  • Offers something refreshing or new
  • Provides further income generation or extended property use
  • Two types of property improvements
  • Capital Works

– When property improvements involved structural renovations, they are under the capital works type.

  • Capital Allowances

– When the modifications involved depreciable items or assets, they belong to capital allowances.

  • Example of Property Improvements

A good example of a real estate property improvement includes replacing an old wall with other features or paint due to the damage caused by renters or tenants. It’s a renovation or modification of the old wall because aside from restoring the efficient functionality of the wall, you are also giving it a new look.

It means that you can’t claim for the deductions of the repair costs because you did the capital works type of property improvements, and so, you should go for the appropriate rebate. Apply for a property improvement deduction instead of a repair deduction.

However, if you will replace the fibrous cement sheet of the wall to its equivalent, you are doing a repair, and thus, you can claim for the repair cost deduction. The reason for that is you are doing more than a restoration job of the efficient functioning of your wall without changing the character of it, despite using a different material.

Repairs and improvements – differentiating the two

When you conduct both repairs and improvements to your rental property, you will only be able to claim the deduction of the cost of your repairs from your income tax. That if you can split or break up the repair cost from the improvement expenses.

Creating an itemised invoice will help in working out your deduction claim whenever you acquire the professional services of a builder or other specialist to execute the work for you.

Example of dividing and allocating expenses between repairs and improvements

When you need to modernise your rental property by acquiring the help of professional builders or tradespeople to apply for rendering and painting works on your external walls and repainting of your internal walls, which became deteriorated in time as the property got rented out, you can request your hired personnel to create an itemized bill or invoice.

In this way, you can separate the cost of the works done on both internal and external walls. By doing so, you can claim for a repair cost deduction for repainting your internal wall and capital works deductions for the works done on your external walls.

It is extremely important to properly categorise every expense or cost you incur to make sure calculations are correct for tax purposes.

How to determine the rental property expense category?

  • Initial repair

When you need to repair property damage, which existed before buying it, and regardless if you know it or not, such as fixing the damaged floorboards, falls under the initial repair category.

For such a case, you can claim the capital works or capital allowances deductions.

  • Repair

The replacements of broken, worn out, or damaged properties and assets that came as a result of renting out the property, such as replacing a damaged fence caused by the storm or hiring plumbing services to fix leaks, belong to the repair category.

You can claim for a repair and maintenance deduction for the costs.

  • Capital Works

Performing a renovation or addition of a new structure to the rental property, such as adding a patio or carport, falls under the capital works, and thus, you can request for the deduction claim relating to capital works for this situation.

Capital works also apply when you purchase an entire structure of a partly damaged construction, such as replacements of the whole fence, not only the broken part.

  • Maintenance

Preventing damage or fixing a deteriorating item that happened while renting out the property, such as repainting faded walls, is a maintenance category. For this situation, you can claim for the repair and maintenance costs deduction.

  • Depreciating asset

Installations of brand-new window covering, new appliance, and floor, among many others, such as buying a new air conditioner or replacing your old carpet, fall under the depreciating asset category.

With this case, replace carpet rental property tax deduction applies or deduction claims for capital allowances should follow.

Expenses involving legal matters

You can also claim income tax deductions for the costs you spent on legal matters.

  • What Deductions Can You Claim For Legal Expenses?
  • When you defend a damages claim by a third party concerning injuries that happened in your rental property
  • Evicting or removal of a non-paying renter or tenant
  • Costs incurred in bringing a rental loss income to the court
  • What Are Legal Expenses That You Can’t File a Claim?

While you can claim certain legal costs deductions, there are several exceptions to the rule. Here are a few of the legal expenses that you can’t file a claim for income tax deductions.

  • The legal costs associated with the resumption of the land, which is a capital expense, is not qualified for a deduction claim.
  • Another capital expense that is not eligible for a claim deduction is the fees paid to the solicitors for the property purchase.
  • The legal expenses brought by defending your property title, which you can get after paying the stamp duty, is another cost that you can’t claim for income tax deductions.
  • Fees paid to the solicitor for the loan documents preparations is also another instance that you can’t file for a claim deduction.

Other than that, you can claim the investment property tax deductions stamp duty if you are under the ACT and within the current year that you incur the cost.