Attention property investors: your friends at the Australian Taxation Office might be taking an a much closer look at your tax return than you will be comfortable with this year.

Assistant tax commissioner Gavin Siebert said the tax office has made property rental deductions a top priority this tax time explaining that…

“A random sample of returns with rental deductions found that nine out of 10 contained an error … We are concerned about the extent of non-compliance in this area and will be looking very closely at claims this year.”

In 2016/2017 there were 2.179 million residential property investors submitting tax returns claiming $47.4 billion in expenses.

This large figure is the honey pot to the ATO bee who sees any reduction in claimable expenses as low hanging fruit to boost the budget.

With significant increases in the ATO’s operating budget particularly with technology, property investors are in the ATO sights.

There are several key areas that the ATO sees as possible ‘errors” made by property taxpayers and 2019 will see a doubling of taxpayers being audited.

And with the ATO estimating  that over 90% of tax returns contains errors it’s easy to understand their new-found enthusiasm in reviewing property investors deductions.

In Australia, the onus is on tax payers to conform with the tax legislation and tax reporting is self assessed i.e. taxpayers submit a tax return advising the ATO of their tax liabilities or in fact the need for a refund.

From here the ATO randomly picks taxpayers for review and audit and in many cases this is automatically generated by the system by comparing claims with average industry or average taxpayer claims on a line item by line item basis.

Over the past few years the significant expenditure by the ATO has been on its computer and data systems which now means that taxpayers have the bulk of their tax returns pre-populated with things such as wages, PAYG tax, interest income and dividends etc.

The State Governments now share data with the ATO such as property purchases and sales as well as land tax assessments.

This allows the ATO to cross check this data with what taxpayer’s supply.

Some of the more common areas taxpayers must pay particular attention to include:

1. Repairs vs. maintenace

The tax man wants to ensure you don’t get immediate tax write offs for improvements by calling them repairs.

In short, a repair brings an asset back to the same condition it was in when you first acquired the property.

An improvement on the other hand is improving the asset beyond its original condition and/or changing the nature of an asset and is depreciated as opposed to written off in the year of expenditure.

 

The cost of repairs can be claimed in full in the year they are incurred whereas an improvement must be depreciated over its useful life.

It is not always easy to ascertain whether a cost is a repair or improvement or both, so in many situations you should obtain tax advice.

Another trap is that repairs made at the time of purchase, before the first tenant moves in to your property are treated as improvements and not immediately tax deductible, but instead are added to the property’s cost base for CGT.

2. Interest expenses

The deductibility of the loan will be determined by its purpose i.e. what were the borrowed funds used for.

So make sure your loans are correctly structured.

Keep good records i.e. you can demonstrate what investment asset each loan relates to.

Errors include incorrectly claiming interest that was not tax-deductible (i.e. debt was not used to produce taxable income e.g. home loan) and/or the loan purpose was not able to be proven by the taxpayer e.g. they mixed purposes in one loan.

Another common problem is when the loan is written in a different name than that of the investment property ownership. This will compromise the tax deductibility but additional loan documents can get this back as fully deductible.

To ensure you can justify the tax deductibility of your loans separate your loans by asset  you’re borrowing against i.e. have a separate loan/s for each property or investment and avoid having one loan for multiple purposes.

And if you refinance and/or loan amounts change, keep thorough records and ensure you have split loans.

If you are looking at periodically depositing funds into a loan for future personal use, then use an offset account as opposed to a redraw facility which the bank will normally favour to your disadvantage.

3. Property divestments

If you sell an investment property you will need to calculate the capital gain (or loss)

This capital gain will be taxable and if your property is owned for over 12 months you will  benefit from  a 50% general discount if purchased with the intention to own the property as an investment.

If you purchased the property with the intention to sell it at a profit, you can’t claim this CGT discount.

 

Capital works depreciation (the depreciation benefit you claim against your tax) needs to be added back to your profits thus increasing the profits from your sale.

But don’t worry too much about this – remember the deduction was at your marginal tax rate whereas the add back is payable after a 50% reduction so it is worth claiming depreciation if only on a time value of money benefit.

If you have been living overseas there are special rules to reduce the 50% capital gains discount you would receive as a resident.

Also…there could also be an element of Capital Gains Tax payable on the sale of your home depending on when and how it was used as an investment.

So as not to get caught by the CGT trap carefully document  what your intention was at the time of purchase?

If it was to “flip” then this is not a capital purchase and a sale would be taxed at normal rates irrespective of the time of ownership.

If the property was a new build, then GST registration would have been required.

This can even apply to a major renovation of an existing residential property.

4. Personal expenses including holiday homes

The tax man is carefully monitoring private expenses that are incorrectly being claimed as investment expenses.

The ATO’s main concern is making sure that any deductions claimed in respect to holiday homes that are rented out for part of the year are correctly apportioned.

If you rent out your holiday home, carefully apportion your  expenses taking into account whether the property was rented at a rate below market (to friends or family), whether it was available for rent during peak periods, if the owners unreasonably refused tenants and whether the owners genuinely took steps to find tenants during periods it wasn’t occupied.

If you own a holiday house that is partly rented out and partly occupied, ensure you use the services of an experienced registered tax agent.

For properties only used for private usage you can accumulated all expenses that would have been deductible if it was an investment to increase its cost base to use to calculate a capital gain if ever sold.

5. Renting part of your home

If you are renting part of your home you must declare the income.

Costs associated with the income are proportionally deductible.

The renting of a room or the total property on say AirBNB must also be reported to the tax office.

Renting part of your home will create annual tax liabilities and therefore a  proportional loss of the Main Residence Exemption  your receive for Capital Gains Tax when you sell – in other words you’ll have to pay some CGT when you sell your home.

6. substantiation of expenses – receipts

The onus is on the taxpayer to prove a tax deduction is legitimate.

In the absences of this proof, the ATO will simply deny the deduction.

 

The ATO find that many taxpayers failed to produce sufficient evidence of expenses claimed e.g. receipts.

As simple answer to this is to  ask your managing agent to pay for all expenses from the rental income they collect for your property.

Doing this means you no longer need to take responsibility for the record keeping.

At the end of the financial year, your property manager will provide you (and your accountant) with a report itemising all your income and expenses for the year.

This saves you a lot of time, hassle and extra work.

At tax time, you then only send your accountant this report, bank statements and depreciation schedule.

If your property is in a Self Managed Super Fund, you must ensure very specific requirements have been met and you must use an SMSF specialist together with a property tax specialist to ensure full compliance from the finance structure, name of the purchaser, bank account and the proper handling of any improvements or repairs and maintenance.

These specialists will also guide you on how to put in place the correct documentation in case of death of a superfund member.

What about the penalties?

The amount of penalties that the ATO seeks to charge for ‘errors” will depend on the circumstances and they will normally range from 25% to 75% of the tax liability plus interest.

Make sure you consult with your specialist property tax accountant as soon as you receive a letter from the ATO.

It is important that you comply with all information requests on a timely basis.

It is also important that an experienced property tax accountant represents you so that all legitimate tax deductions are correctly verified and explained.

If penalties are payable, your tax agent may be able to negotiate with the ATO on your behalf.

You can “insure” against these issues by taking out “tax audit insurance” to cover the cost of accountancy and legal fees if you are audited by the ATO.

This can also cover the State Government for Land Tax or Stamp Duty disputes.

This cover is worth considering, especially if you are self-employed or have complex tax affairs.

Ask your accountant about this.

Talk to your property tax specialist to ensure you will be able to legitimately claim any expenses as well as identifying what you can claim.

As an example, if you own property with another person then you need a specific type of depreciation schedule to allow you to maximise the initial year’s deductions.

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