Last updated June 2011

More individuals are now purchasing rental properties as investments, which has motivated the ATO to increase their audit activity in this area. Their investigations continuously show that people get things wrong when claiming deductions against their rental income. 

Rental Income not at Market Value:

People sometimes rent properties at a discounted rate, often to related family members. However, this can have serious ramifications from a tax perspective.

If a rental property is rented out at less than commercial/market rates the Taxation Office may limit the deductions being claimed to the amount of income received (they have court support for doing this). For example, if a property is rented out at $100 per week, and the commercial rate for the property is $300 per week, deductions against this income may be limited to $100 per week i.e. any expenses above the $100 per week will not be deductible for tax purposes even though they have been incurred.

Thus, any negative gearing tax advantage will be cancelled out. 

 What you can Claim:

There are a wide range of expenses that you can claim on rental properties - much more than rates, interest and rental agent fees. It is an area where using an accountant with the relevant experience can produce significant benefits.

Further benefits can sometimes be obtained by engaging the use of a quantity surveyor as well, particularly if the property is fairly new. But again you should ensure they have experience in this area.

Here at Patison Partners we have extensive experience in this area and contacts with quantity surveyors, so ensuring that you are not short-changed when it comes to claiming deductions.

It is relevant to note that a wide range of costs, such as those associated with purchasing and disposing of your rental property cannot be claimed as an expense. Instead, these costs form part of your cost base for the purpose of calculating capital gain/loss upon disposal.

Repairs and Maintenance versus Capital Expenditure

This is a common trap for the inexperienced, as some repairs you make to a rental property can be claimed as a tax deduction in the year you incur the expense and other expenses cannot - they must be capitalised and form part of the cost base for capital gains tax purposes.

For example, if you buy a run down property cheap and fix it up before renting it out, the costs of fixing it up, whilst being 'repairs', may have to be capitalised.

Likewise, if you find yourself having to fix something because it is broken, but decide to replace it with something better, you may find the Taxation Office will require you to capitalise the cost.

The Commissioner uses the tax return information such as the date the property is acquired and the repairs claimed compared to the rent received as an indicator of an audit target. Beware!

You can deduct certain kinds of construction expenditure, generally at a flat rate. This expenditure includes such things as the original construction costs, adding a room or garage, building an extension, pergola, sealed driveway etc. Landscaping is not a structural improvement.

Negative Gearing is simply where the income you receive from your investment is less than the tax deductions you can claim. For example, if you received rent of $10,000 for the year and your expenses totaled $15,000 (e.g. mortgage interest and agent fees) during the same year, you have negatively geared by $5,000.

For tax purposes the loss you made can then be used to reduce the amount of tax you will have to pay on income from other sources (e.g. your salary/wages taxable income).