You feel the chill in the air, winter is coming and that can only mean one thing - it’s tax time! But this time, you'll be heading into it knowing how to reduce tax on your investment property.
Whether you only just recently acquired your first investment property, or you’re already investing in a substantial real estate portfolio, are you aware of all the income tax deductions that investment property owners like you are entitled to?
To help you ensure you’re not paying more tax than you need on your rental, we've put together five practical strategies to maximise your returns and lower your liabilities at tax time. You'll get some smart ways to reduce your taxable income from your property and tips for making it easier.
Remember to check with a registered property tax consultant to get professional advice for your personal situation.
1. Keep clear, up-to-date records of all your expenses
The easiest way to get a tax break on your investment property is through tax deductions.
To do this, you'll need to keep track of your receipts and bank statements.
The ATO requires you to keep records of:
- The date and cost of purchasing your property (to work out if you incur a capital gain or loss when it comes time to sell)
- Any rent or rent-related income to report at your annual tax return
- Any expenses you want to claim deductions for, which should include: The name of the supplier, the expense amount, the nature of goods or services and the date of the expense.
There are countless different ways you could go about organising these documents - by keeping physical statements in a binder, by manually filing them in a folder in your computer, by using apps like Expensify that keep track of your expenses... the list goes on.
A property manager can also help. The great thing about technology in property management is that it's made tax-time much easier. At :Different you can download your annual statement free of charge to get a full overview.
If you'd like to know more about what this looks like, you can read about how :Different gets owners ready for the end of financial year or have a peek at the picture below.
For your home and property management related tax deductions, you'll benefit from having them all in one place.
2. Understand the difference between capital works, repairs and maintenance
Think all repairs and maintenance costs can be claimed as the same type of deductions for your investment property? Think again!
The ATO has specific classifications for repairs, maintenance and capital works. When filing your tax return, you’ll need to categorise these expenses appropriately to ensure your deductions are lodged correctly if you want to reduce tax on your investment property.
- If you’re replacing something that is worn out, damaged or broken by your tenants, this is considered a repair.
- If you’re preventing or fixing an item that has deteriorated in quality since renting out your investment property, this is considered maintenance.
If you’re replacing an entire structure that is partially damaged (such as all your property’s fencing) or adding a new structure (such as a carport), this is considered a capital work.
3. Claim capital assets and borrowing expenses
You can also get tax breaks on your investment property’s capital asset expenses and borrowing expenses. However, whether you will be able to claim the full expense as a rental property tax deduction in the same year will depend on the value of the expense.
Capital items valued over $300, such as washing machines and fridges, have to be claimed over time.
These items are also known as depreciating assets, as they have a limited effective life and will have their value decline over time and use.
For these assets, you can claim the total cost over its expected life. Some items have special rules that allow you to claim tax deductions more quickly. This guide by the ATO covers in detail the rules around claiming tax deductions for capital assets and how to work out their effective life.
Capital item expenses under $300 can be claimed immediately in the same financial year you purchased them in. However, note that if the item is part of a set of items (e.g. you bought 1 dining chair for $250 as a set of 4 dining chairs), then you cannot claim the full deduction immediately as the total value of the set of items is over $300.
Borrowing expenses include any expenses associated with taking out a loan for your investment property, and can be used to reduce tax on your investment property. Some examples of this is are:
- loan establishment fees
- lender’s mortgage insurance (insurance taken out by the lender and billed to you)
- stamp duty charged on the mortgage
- title search fees charged by your lender
- costs for preparing and filing mortgage documents (including solicitors’ fees)
- mortgage broker fees
- fees for a valuation required for a loan approval.
If these expenses are under $100, you can claim in-full that financial year. If not, you can spread this deduction out over 5 years or the term of your loan (whatever period is shorter).
This worked example provided by the ATO shows how tax deductions for borrowing expenses are calculated and could be useful for you to calculate the tax break for your portfolio.
4. Track your depreciation and capital works schedule
A depreciation schedule is a record of the property’s capital assets valued over $300, and it outlines how much you can claim in depreciation each year. It's a great way to decrease how much tax you'll pay on your rental property.
Since you can expect many of your capital assets (e.g. washing machines, carpets, etc.) to depreciate over time, you’ll be able to claim deductions over the course of its life.
Similarly, you can claim capital works deductions over a number of years for certain construction costs. This means that even work done building your investment property can become an income tax deduction.
A capital works schedule is a useful record of all the construction and building related work for your investment property.
It consists of:
- Preliminary expenses such as surveying, engineering and architect fees
- The cost of building permits
- The cost of building and construction materials
- the cost of altering or extending a building
- the cost of capital improvements to the surrounding property or structural improvements to the existing property
This schedule is also crucial when calculating the amount of tax deductions you can claim each year for your investment property. Typically, you can claim tax deductions for capital works for 40 years after the work is completed. To be eligible for this tax deduction from the ATO, your property needs to satisfy two conditions:
- Be built after July 1985
- Is being rented or genuinely available for rent
The ATO also provides a handy tool for you to calculate your depreciation and capital allowance.
Your property tax consultant will be also able to explain and help you work out how much and over how many years you can claim your tax deductions in more detail.
It's important to know that if you can’t accurately work out the building expenses of your property, the ATO only deems quantity surveyors as suitably qualified to provide the schedule. That means that although your accountant can help you keep an accurate schedule, they cannot estimate the construction costs for you.
5. Negatively gear your investment property
If the rental income on your property is less than your interest payments and expenses for the year, then your property is negatively geared. You might be wondering - is this a bad thing? Not necessarily.
In fact, it's one of the best ways you can reduce income tax on your rental property.
It comes with significant tax benefits. As a result, 60% of investment properties in Australia are negatively geared.
Although you can’t gain any tax deductions directly through negatively gearing your investment property, you’re able to reduce your taxable income, which indirectly reduces the amount of tax you pay.
This means that you will be eligible to deduct the loss from your taxable income.
If you’re looking to minimise the amount of tax you pay on your investment property, you can keep this investment strategy in mind.
Bonus: Use a property manager
Now you know what investment property expenses are tax deductible - but how can a property manager help?
A great property management system can help you keep all your expenses in one place. That way, you’ll less likely need to embark on a statement hunt through email after email, or through the stacks of paperwork in your home, at the end of every financial year.
To make the most of your property manager’s services for tax purposes, it’s incredibly helpful to ask them to organise and pay all contractors, rates, and other expenses.
In a survey we conducted with our owners leading up to end of financial year this year, 78% expressed that compiling statements and receipts was their biggest tax-time pain point. In response, we rolled out an EOFY pack that made tax time easier for 1413 owners.
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