If you’re a property investor, today’s episode is a must.
Why? Because the tax man is after you – you and all property investors.
Recently, the tax department recognised that 90% of property investors’ tax returns contain an error.
9 out of 10!
They’ve found a number of common errors, and today Ken Raiss and I are going to tell you what they are and how to avoid them.
Remember, if you follow the letter of the law, you’ll have no reason to worry even if you do get audited.
Will your rental property make you a target for the tax man?
The Australian Taxation Office might be taking a much closer look at your tax return this year than you would like.
Due to 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 taxpayers being audited.
And with the ATO estimating that over 90% of tax returns contain errors it’s easy to understand their new-found enthusiasm in reviewing property investors deductions.
Some of the more common areas taxpayers must pay particular attention to include:
1. REPAIRS VS. MAINTENANCE
The tax man wants to ensure you don’t get immediate tax write-offs for improvements by calling them repairs.
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.
2. INTEREST EXPENSES
The deductibility of the loan will be determined by its purpose.
So, 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. a home loan) and/or the loan purpose was not able to be proven by the taxpayer e.g. they mixed purposes in one loan.
3. PROPERTY DIVESTMENTS
If you sell an investment property you will need to calculate the capital gain (or loss)
This capital gain will be taxable and if your property is owned for over 12 months you will benefit from a 50% general discount if purchased with the intention to own the property as an investment. If you purchased the property with the intention to sell it at a profit, you can’t claim this CGT discount.
Capital works depreciation (the depreciation benefit you claim against your tax) needs to be added back to your profits thus increasing the profits from your sale.
4. PERSONAL EXPENSES INCLUDING HOLIDAY HOMES
The ATO’s main concern is making sure that any deductions claimed with respect to holiday homes that are rented out for part of the year are correctly apportioned.
If you rent out your holiday home, carefully apportion your expenses taking 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.
5. 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 also be reported to the tax office.
Renting part of your home will create annual tax liabilities and therefore a proportional loss of the Main Residence Exemption you receive for Capital Gains Tax when you sell – in other words, you’ll have to pay some CGT when you sell your home.
6. SUBSTANTIATION OF EXPENSES - RECEIPTS
The onus is on the taxpayer to prove a tax deduction is legitimate.
In the absence of this proof, the ATO will simply deny the deduction.
The ATO found that many taxpayers failed to produce sufficient evidence of expenses claimed e.g. receipts.
A simple answer to this is to ask your managing agent to pay for all expenses from the rental income they collect for your property.
Doing this means you no longer need to take responsibility for record-keeping. At the end of the financial year, your property manager will provide you (and your accountant) with a report itemising all your income and expenses for the year.
What about the penalties?
The number 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.
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.
Links and Resources:
Metropole’s Strategic Property Plan – to help both beginning and experienced investors
Some of our favourite quotes from the show:
“Occasionally investment loans get tainted with private issues as well, and the tax man is looking at that a bit more carefully.” – Michael Yardney
“The idea is to put all your excess cashflow – and often the rent – into your offset account, but it’s really important to document everything very carefully, keep thorough records.” – Michael Yardney
“The tax man is after you, but they don’t even know who you are. You’re just a number. Don’t be scared by it, but prepare yourself by putting your house in order before you start.” – Michael Yardney
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