When it comes to investment properties, regardless of the type — whether it’s a holiday home, residential rental or an NDIS property — the income earned (or the loss incurred) is included on your annual income tax return. The Australian Tax Office (ATO) is cracking down on landlords incorrectly claiming deductions for ineligible expenses. We take you through the most common investment property errors included in tax returns.
How does the ATO ensure rental property data is correct in tax returns?
To reduce the risk of errors in tax returns, the ATO has implemented a data-matching program for residential investment property loans. The ATO collects data each year, after the end of the financial year, from 17 financial institutions. This data helps to identify any landlords incorrectly claiming deductions, failing to declare rental income or paying capital gains tax.
Based on sample audits, it’s estimated that in the 2020 financial year, people owed about $9 billion in taxes they hadn’t paid, which is 5.6% of the total taxes owed. A big reason for this 5.6% underpayment gap is the mistakes made in reporting rental property income and expenses. Out of the $9 billion, $1 billion comes from errors in reporting rental property expenses, making up 14% of the overall gap. One common mistake is people wrongly apportioning loan interest costs where the loan was refinanced or redrawn for personal use. This highlights the importance of carefully structuring your finances so owner-occupied mortgages are not confused with investment property loans.
Common tax return errors to avoid
The three most common investment property errors on tax returns are as follows.
Incorrect apportioning of interest expenses
According to the ATO, many taxpayers are incorrectly claiming interest expense deductions when the finance has actually been used for personal use — rather than in the course of earning income.
Their focus is set on people who are refinancing or redrawing funds from investment loans and using them for personal purposes. Interest paid on funds for personal use is not eligible for a tax deduction, so borrowers need to proceed with caution when looking to redraw from investment property loans. If the redrawn funds are used to produce investment income, the interest expense will likely be tax deductible, so it’s important to fully understand the intention behind redrawing these funds.
Incorrectly claiming renovation costs
Knowing the distinction between repairs and capital costs is crucial because repairs can be deducted from taxes right away, while the expense of capital improvements can only be deducted gradually over the asset’s lifespan. A renovation requires an updated depreciation schedule, whereas the cost of general maintenance can be claimed immediately.
If you have undertaken renovations or significant property additions, it’s important to get an updated tax depreciation schedule prepared before your next tax return is submitted. Failure to do so may catch the attention of the ATO. It’s also a good idea to keep detailed records in the event that you need to substantiate your claim and provide further evidence of the nature of the repair or upgrade.
What do capital costs include?
For NDIS investment properties and general residential homes, capital costs include structural improvements, such as:
- Roof replacement,
- New wet areas,
- Moving walls.
Expenses claimed for private use of a property
Many investment property owners are incorrectly claiming tax deductions for expenses that partially relate to personal use. Only expenses relating to income-producing activities can be claimed, so if any of the following scenarios apply, you need to calculate the portion of the expenses that relate to income-producing activities rather than claiming the total expense:
- The property is used for personal purposes at periods throughout the year.
- Only part of the property is used to earn rent.
- The property is rented at non-commercial rates.
- The investment loan is partially used for personal purposes (discussed in point one).
With specialist disability accommodation (SDA), you’re unlikely to be using the property for personal use unless you require accessible housing. However, it’s important to take note of how you’re using your NDIS home loan. If you’re redrawing funds or refinancing the investment loan and using a portion for personal purposes, you could be at risk of claiming more than you’re entitled to.
We’re here to help
Your financial adviser or taxation accountant will be able to help you determine the appropriate deductions to include on your tax return when it comes to your investment property portfolio. If you’re thinking about refinancing an investment loan or redrawing to cover personal debts or expenses, we’re more than happy to help structure your finances. Please get in touch with us for a chat.