Investment property deduction mistakes at tax time

The ATO are cracking down on investment property deductions this tax season. Here’s two classic mistakes and how to avoid them.

The ATO reported last week that 90 percent of property tax claims had an error. With $47 billion being claimed in rental deductions in 2017-18 year, the ATO are on the lookout for these common errors this tax season.

Director of Tax Services Todd Want outlines two classic mistakes and how to avoid them.

Scenario one: Claiming interest where part of the loan was used for private purposes

Example: Redrawing on a loan for private purposes

Todd says there is a common misconception that the asset a loan is secured against dictates whether the interest on the loan is tax deductible, however this is not the case.

“If a loan has been secured against an investment property, people often assume that the interest on the loan is therefore tax deductible, but this approach is not correct. The use of funds – what the loan funds were used for – dictates whether the interest on the loan is deductible. If you borrow the money, you need to ask yourself, ‘what were the funds used for?’”

“A common and major problem is when people treat their loan account as though it is a regular bank account. Deposits to the account and withdrawals from it could be for a variety of private, investment or business purposes. Where there are these different purposes, it makes the consideration of the tax aspects far more complicated.”

“If you have a loan that you use to buy an investment property, but then you draw down on the loan and pay for a holiday or a car– the purpose of the loan is now partly investment and partly private, meaning that only some of the interest on the loan is likely to be tax deductible. Ideally separate loans would be maintained for the investment property and for the private expenditure, but this is not always possible.”

“Documentation is critical. Having good records to be able to keep track of what has happened in the loan over time is vital. This can become even more problematic if someone has refinanced and consolidated multiple loans into one.”

“Ultimately though, if you are seeking to claim a tax deduction for any of the interest on the loan, you need to be able to support the position that you have adopted.”

Scenario two: Claiming immediate deductions for items that need to be claimed over a number of years

Example: Having a repair that is actually an improvement.

Todd says the distinction between repairs and improvements is a common scenario that people get wrong.

“If you have had an investment property for a number of years and an issue arises that needs repairing, you may be able to claim a tax deduction for the costs. However, you need to be careful that you haven’t gone above and beyond a repair – have you replaced like for like in terms of quality and functionality, or have you improved the asset?”

“Let’s say you have a timber front gate at the entrance of your investment property that needed repair. However, you decided that you wanted to replace it with an electronic gate instead. In this instance, you may be taking it above and beyond repair. You may fall into the situation where the whole cost of the gate is not deductible in the year of replacing it, but instead needs to be depreciated and claimed as a tax deduction over time. Importantly, you can’t say, ‘well it would have cost me three grand to repair it like-for-like, but I spent ten, so I will just deduct the three and the seven is capitalised’. You must depreciate the whole cost over time.”

“Capital versus repair and maintenance is a longstanding area of interpretation, with case law dating back decades. It is this interpretation where people get caught out. The key point here is – were the materials the same, or similar and does the repair achieve the same function? If you replace it with something that is superior, then you probably can’t claim the deduction, it must be depreciated over a number of years.”

Read more seasonal holiday homes on ATO radar this tax season

If you need assistance understanding your property tax deductions, call an expert today.

Investment property deduction mistakes at tax time

Amy Kitson