Property investors are in ATO's sights

Property investors are in ATO's sights
Nicki Bourlioufas
June 23, 2007

PROPERTY investors need to watch out because they are probably on the Australian Taxation Office's hit list this year for a tax check.
More than 1.4 million people claimed more than $21 billion in rental deductions in their 2005-06 tax returns.

This financial year, the ATO has written to 45,000 individuals considered at risk of not complying, reminding them to check the accuracy of their claims before lodging returns.

According to the ATO, it will examine about 6000 at-risk cases.

It will check the accuracy of capital gains declared by investors and match the data against records from state and territory revenue and land-title offices.

It will also check figures provided by investors to third parties such as banks.

Yet, the fact remains, the opportunity for deductions in investment properties are often greater than for borrowing to invest in shares because of the number of deduction possibilities.

For a margin loan, the main expense is interest but there are two categories of rental property expenses that investors can claim.

First, expenses in the year they are paid: council rates, repairs, maintenance, insurance, land tax and property management fees, as well as interest costs on an investment loan.

Second, expenses deductible over several years: borrowing transaction costs, the costs of depreciating assets and capital works deductions on structures.

Getting it right

FROM 2007-08, the ATO will issue pre-prepared returns.

Taxpayers will be able to go online to access an income-tax return prepared by the Commissioner of Taxation and based on past data that will include income from salary and wages, interest and dividends.

"That just shows you how much information they now have on individual taxpayers and how much they are collecting," PricewaterhouseCoopers tax partner Mike Forsdick says.

If an investor's tax-deductible expenses on a property exceed the rental income, the loss can be offset against other income, such as salary, to reduce tax payable. In this way, negative gearing is most beneficial to investors who pay tax at the highest marginal rate of 45 per cent because the ATO covers almost half their loss.

"Borrowing costs are tax-deductible, but only over several years, Mr Forsdick said.

"These costs, which include loan establishment fees, mortgage insurance and stamp duty on the loan, must be deducted over life of the loan or five years, whichever is shorter.

Investors can't claim costs associated with buying or selling a property, although these elements may form part of the cost base of the property for capital gains tax purposes.

When deductions are made, the property must be available for rent.

"You can only claim expenses if the property is available for rent," Forsdick says. "If a property is sitting empty, you can still claim expenses if it is available for rent, but if it isn't available, you can't claim expenses for that period."

The higher the expenses on a property investor's tax return, the more likely they would be checked by the taxman, so it was important to keep good records, Forsdick says.

"It's not uncommon for the ATO to send out questionnaires to people who own investment property, particularly if there are large deductions," he says.

A common sticking point is repairs.

Those related to the wear and tear of assets in the building are tax-deductible, but repairs or renovations carried out to get a property ready for rent or for capital improvements are not expenses.

"One of the traps is spending money getting a property into shape before renting it out," Forsdick says.

"Expenses incurred to get a property ready for letting are capital expenses and must go on the cost base of the property for capital gains tax purposes."

Depreciation allowances can enhance after-tax returns.

Investors can depreciate capital works deductions for the construction cost of residential buildings built after July 1985 and for structural improvements, and depreciation can be claimed for wear and tear on fixtures and fittings in the property. Buildings are depreciated at a rate of 2.5 per cent or 4 per cent a year, depending on when they were built.

The cost of a house built in 1990, for example, can be claimed at 2.5 per cent for 40 years until 2030, provided it is used as an investment property.

According to property depreciation specialist Depreciator, up to 80 per cent of property investors don't correctly claim depreciation on their investment properties.

Depreciator general manager Scott Brunsdon estimates that depreciation deductions on a new house can amount to $10,000 a year, and those for a seven-year-old house could be between $3000 and $4000.

"Deductions on new units in large complexes can, in many cases, be around $14,000 per year for the first couple of years," Brunsdon says.

Napier and Blakeley tax depreciation services regional manager David Liddelow says, investors generally would get more deductions for a new high-rise development than for a house because there were more plant depreciation allowances.

"With a house, you can depreciate the structure and depreciable assets, but you don't have the shared facilities," he says.

Liddelow says investors who buy into strata properties can claim depreciation allowances for common property.

"When you buy into a strata property, you are entitled to a share of the depreciation, usually based on the unit entitlements of the strata plan," he says.

A tax depreciation schedule is an important element of owning an investment property.

It lists all items in an investment property that are falling in value, as well as annual depreciation allowances, including capital works deductions.

Some new properties come with a TDS, but investors would be prudent to get their own report prepared, Liddelow says. "We are a little bit wary of a free TDS as it may not list all deductions you're entitled to," he says.

Although a TDS is prepared by a quantity surveyor, the numbers are often used by an accountant to complete a tax return.