ATO warns rental property owners: don’t let your tax return become a ‘fixer-upper’

The Australian Taxation Office (ATO) is putting rental property owners on notice this tax season.

ATO Assistant Commissioner Rob Thomson has highlighted that many rental property owners are making mistakes on their tax returns, despite 86% using a registered tax agent.

One major issue is misunderstanding what expenses can be claimed and when particularly distinguishing between repairs and maintenance versus capital expenses.

Other errors include overclaimed deductions and insufficient documentation to back up the expenses claimed.

Mr Thompson said:

"We understand rental property owners may already have long lists of things to fix in their properties.

But by getting your tax return right the first time, you’ll avoid having to add ‘fix up tax return’ to your to-do list down the track."

The ATO cross-checks data from banks, land title offices, insurance companies, property managers, and sharing economy providers to verify the accuracy of tax returns lodged by rental property owners.

Mr Thompson advised:

"If you use a tax agent, make sure you provide them with all records of your expenses.

If you have a nagging question or something that doesn’t make sense, ask your agent when you’re working with them.

Rental property investments and taxation can get tricky, so it pays to get the right advice from the beginning.

Don’t rely on things you hear at a Sunday afternoon barbecue."

Dodgy deductions

Deductions can only be claimed to the extent they are incurred in producing income.

For instance, costs incurred in generating rental income each year can be claimed for that period, with some exceptions.

Mr Thompson explained:

"It’s normal for landlords to have to fix or replace damaged items in a rental property.

But there is a myth that all expenses can be claimed immediately.

Repairs can usually be claimed straight away, but capital items, such as dishwashers, curtains, or heaters, can only be claimed immediately if they cost $300 or less.

Otherwise, they need to be claimed over time."

A common issue is the ‘double-dipping’ on expenses that the property manager has already arranged and included on the property’s income and expenses report.

Rental property owners can only claim for amounts they incur, even if there are two records for the same expense.

Interest on mortgages is one of the most commonly claimed deductions.

However, incorrectly reporting interest expenses accounts for 42% of the $1.2 billion Individuals Not in Business tax gap associated with rental properties.

Problems arise when taxpayers redraw or refinance a loan for their rental property and use the money for private expenses, then claim the whole amount of interest charged on the investment loan as a deduction.

Mr Thompson clarified:

"For example, if you have an $800,000 mortgage for a rental property and then add $50,000 to the loan to upgrade your family car, you can only claim the interest on the initial $800,000, not the interest on $850,000."

Payments must be apportioned between the private and investment components for the life of the loan.

Additionally, while levy payments to body corporate administration funds and general-purpose sinking funds are deductible, special-purpose fund payments for capital expenditure are not deductible until the capital works are complete and the expense has been billed to the body corporate.

Risky records

A lack of documentation to substantiate claims of expenses and deductions is another leading cause of errors.

Mr Thompson advised:

"You need to keep detailed and complete records, including receipts, invoices, and bank statements for interest expenses.

You should also detail how you calculate your deductions and any apportionments.

This will allow you or your tax agent to correctly complete your tax return."

Records can be paper or electronic but must include:

• The name, ABN, or business name of the supplier
• The amount of the expense
• The nature of the goods or services purchased
• The date of purchase
• The date the document was produced

Claims for capital works aren’t based on the purchase price of your property but on the construction cost when it was built.

A quantity surveyor or suitably qualified professional can help prepare a capital works deduction schedule, but this is not mandatory.

Mr. Thomson emphasized:

"Taxpayers are responsible for what they include in their tax return, even when using a registered tax agent.

If you don’t have sufficient records, you can’t claim it."

Careless capital expense claims

The ATO is also cautioning against incorrect claims for capital expenses.

Repairs, like fixing a dishwasher, can generally be claimed immediately, but buying a new dishwasher cannot.

Some expenses, including improvements and capital works, must be claimed over time.

For example, remodelling a bathroom in your rental property is typically claimed at 2.5% over 40 years.

Mr Thompson said:

"Spending money to fix something could be a repair, initial repair, capital works, or a depreciating asset.

Our Investor toolkit can help you understand the difference, as the amount you can claim as a deduction this tax time will depend on which category it falls into."

Case study: claiming cooktops

The ATO cited a case study about a Melbourne taxpayer who was selected for review shortly after listing a rental property.

The taxpayer’s registered tax agent provided a list of deductions, including new blinds, a cooktop, and air conditioners as immediate deductions.

These items should have been categorized as depreciating assets and claimed over time.

The taxpayer also purchased a new cooktop for their personal home in the same transaction and tried to claim both cooktops in their tax return.

The ATO queried this as the rental property only had one kitchen.

The taxpayer didn’t provide proper records to their agent, resulting in avoidable mistakes.

The taxpayer’s return was adjusted by the ATO, and penalties and interest were applied.

About Sam Alaaeddin With well over a decade's experience in asset and wealth management, Sam is an Elite Wealth Planner at Metropole and leverages his expertise to help clients achieve their wealth management goals. He holds a bachelor’s degree in law and commerce (Finance) and a Diploma in Financial Planning.