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 tax payers being audited. The ATO estimates that over 90% of tax returns contains errors and hence the 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 tax payers 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 tax payers must pay particular attention to include:
Repairs and maintenace
- 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.
- Repairs at the time of purchase before the first tenant are treated as improvements and not immediately tax deductible but added to the property cost base.
Interst expense
- The deductibility of the loan will be determined on its purpose i.e. what were the borrowed funds used for.
- 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 the investment property ownership. This will compromise the tax deductibility but additional loan documents can get this back as fully deductible.
- In short, separate loans by asset i.e. separate loan/s for each property or investment – 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.
Property divestments
- If you sell an investment property you will need to calculate the capital gain (or loss)
- the capital gain will be taxable and if owned for over 12 months there is a 50% general discount if purchased with the intention to have it as an investment
- capital works depreciation needs to be added back to decrease the cost base thus increasing profits. 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 had any overseas living there are special rules to reduce the 50% capital gains discount
- There could also be tax payable on the sale of your home depending on when and how it was used as an investment.
- What was the intention 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.
Personal expenses including holiday homes
- 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.
- Apportionment of expenses must take 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.
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 be reported.
- Renting part of the home will create annual tax liabilities and the proportional loss of the Main Residence Exemption.
Substantiation ie 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.
- I always recommend that you ask your managing agent to pay for all expenses from the rental income they collect. To do this, change the delivery of all bills or forward each bill by email. Doing this means you no longer need to take responsibility for the record keeping. At the end of the financial year, the agent can provide you (and your accountant) with a report itemising all 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 property tax accountant this report, bank statements and depreciation schedule.
If the 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.
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 property tax specialist 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, the tax agent may be able to negotiate with the ATO on your behalf.
You can obtain tax audit insurance to cover the cost of accountancy and legal fees if you are audited by the ATO which 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.
