Time to review negatively geared rental claims.
The ATO have recently announced they will double the number of audits in relation to rental property deductions. Specifically, the ATO will focus on over-claimed interest, capital works claimed as repairs, apportionment of expenses for holiday homes and accommodation sharing.
It’s noteworthy; they have stated they will be searching social media and other online content to assist in determining rental claims.
In 2018, more than 2.2 million Australians claimed over $47 billion in deductions. This was even after the recent withdrawal of travel deductions to inspect residential property (which took effect from 1 July 2017). Please note – this removal of the claim of ‘costs of travelling for property maintenance’ does not apply to commercial rental property.
AVAILABLE FOR RENT
The property must be genuinely “available to rent” if claiming expenses. If your property is not tenanted, and therefore not deriving rental, deductions may still be claimed if the property is “available”.
To prove availability, the property must be marketed including advertising and without unreasonable conditions. Advertising by word of mouth is not considered a genuine attempt.
If your property is rented to an associate, rent should be charged at market value in order to claim 100% of the deductions. If this is not the case, you are only entitled to claim deductions up to the amount earned.
A practical application of this area of concern is that you might only claim expenses for 48 weeks (of 52 per annum) because you use the other 4 for your personal needs.
You must make a reasonable estimate where you are making a proportional claim, where the property is located in a seasonal holiday area. ie In Christmas holidays the rental could be significantly higher than other times in the year.
Many investors will draw a loan to fund the acquisition of a property. Sometimes, the loan will fund other investments other than the acquired property, also known as a “dual purpose loan.” Care needs to be taken when claiming loan interest deductions on dual purpose loans as interest is only deductible to the extent of the income producing use. You should ascertain deductibility of each purpose based on whether the funds are used to derive income. An apportionment method should be adopted to calculate the correct loan interest deduction.
This is fundamentally logical but becomes a little complex with principle reductions take place and there is a motivation to slew the reductions against the non-deductible loan component.
As announced in the 2017 budget, Chattels acquired as part of a property purchase price which include second hand assets acquired after 8 May 2017 for residential property are denied a deduction.
Assets acquired from a third party for the property continue to be depreciable as does assets included in new residential premises, provided no entity was previously entitled to a depreciation deduction for the asset.
The rules are unchanged but audit activity from the ATO has uncovered significant incorrect claims.
The difficult distinction is when repairs are deductible or capital? To qualify as a repair, the work undertaken cannot improve the property and must only restore the property back to its original state. Whilst allowance needs to be made for technical advances, which clearly deliver some improvement, the ATO is interpreting this area narrowly.
The distinction is important because if the repair is a capital amount it is written off at 2.5% or 4.0% per year instead of being immediately deductible.
A further area of major concern is called “initial repairs” and relates to repairs carried out AFTER the acquisition of a property. If the area to be repaired or need of repair existed at the time the property was acquired it is deemed non-deductible, due to it being considered as part of the capital cost (ie a reduction) of the property at the time.
The practical application of this concept is that the ATO will look at all repairs in the first 1 or 2 years after a property has been acquired.
These issues mean any repairs being undertaken should be carefully considered and if possible structured for the optimal taxable outcome before commitment, especially if they involve a significant amount.
In the 2018 year, the ATO audited over 1,500 taxpayers with rental claims and applied penalties totalling $1.3 million.
In one case, a taxpayer was penalised over $12,000 for over-claiming deductions for their holiday home when it was not made genuinely available for rent, including unavailability over seasonal holiday periods.
Another taxpayer was required to pay back $5,500 because they had not apportioned their rental interest deduction to account for redraws on their investment loan to pay for living expenses.
If you’re concerned about this announcement and would be interested in reviewing your Negatively Geared Rental Property claims. Please contact Connolly & Associates for peace of mind.