Landlords, the ATO and deductions

September 2012

One in seven taxpayers in Australia are property investors. Each year we claim around $5 billion in rental losses.  So you can understand the Australian Tax Office's (ATO) close scrutiny of the deductions claimed by landlords.  But a recent case before the Administrative Appeals Tribunal (AAT) demonstrates how far the ATO will go to test the boundaries of what is and isn't deductible.

Income vs expenses for investment property
In this case the taxpayer owned a property in country NSW.  The owner stated that the property was available for rent but she had been unable to find tenants.  As a result, the property did not derive any income for a number of years. The owners however had incurred the costs of interest on the property loan, maintenance costs, and rates, which they claimed as a deduction.

The Tax Commissioner had a different view and denied the deductions.  The central issue was whether the property was genuinely available for rent. 

If it was not available for rent then the expenses incurred by the taxpayer are not deductible.  If the property was available for rent, then the expenses are deductible.  This is because you must show that the expenses were incurred in gaining or producing income, even if no income was actually produced in that income year.  

Proof of rent and the ATO
What's interesting in this case is how far the ATO will go.  The ATO used electricity and telephone records to argue that the taxpayer had been living in the property and that it was not genuinely available for rent. Fortunately for the taxpayer, the AAT accepted that she had only lived in the property while carrying out repairs and maintenance work.  

So, even if a property is not deriving rental income during the relevant income year, taxpayers may still be entitled to deductions for interest expenses, council and water rates and other holding costs. The key issue is whether the property is genuinely available for rent and whether continuing efforts are being made to improve the property to attract renters.

The AAT also accepted the taxpayer's argument that she had genuinely tried to rent the property.  She had evidence of some limited newspaper advertising but stated that the most effective way to find tenants for this particular property was through word of mouth.  

Record keeping is essential
The case did not go all the taxpayer's way. The AAT upheld the Commissioner's decision to disallow a number of deductions because of a lack of supporting documentation.  

Broadly, there are two types of rental property expenses you can claim:
  • Expenses you can claim in the year that you paid for them – for example, council rates, repairs, preparation of lease agreements, insurance and loan interest; and
  • Expenses that are deductible over a number of years - these are either:
    • Depreciating assets - where deductions are claimed against income over the life of that asset.  For example, if you replaced an electric hot water system in your rental property, you can claim a deduction for the hot water system over its life, in this case 12 years.
    • Capital works – where deductions are claimed for building construction and structural improvements.  For example, remodelling a bathroom or building a pergola are considered to be capital works and written off at the rate of 2.5% per year.
If it's new, bigger and brighter than what was already there, it's likely to be capital expenditure and depreciated. But, to claim a deduction, the property must be genuinely available for rent.
More information
If we can assist you with any additional information about your rental property and how to manage it effectively, please contact us on 02 9957 4033.

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Last updated September 2012. This article is provided for information purposes only and should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.

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This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.

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