RENTAL PROPERTIES – what’s not deductible

Allowable tax deductible expenditure
Allowable tax deductions for rental properties are generally for expenditure incurred in the derivation of rental income, including interest on borrowings used to purchase the rental property; repairs and maintenance but not “initial repairs”, real estate agents’ management fees; land tax; and costs incurred on travel for the purpose of inspecting the rental property.

Non-deductible expenditure
Rental property expenses that cannot be claimed as a tax deduction include:

1. Costs of acquiring and disposing of a rental property.
Examples of expenses of this kind include the purchase price of the property, conveyancing costs, advertising expenses and stamp duty on the transfer of the property. However, stamp duty incurred on a lease of a property may be claimed as a tax deduction.

For property acquired after September 19, 1985 these non-deductible costs will form part of the cost base of the property for capital gains tax (CGT) purposes.

Generally, where expenses have been claimed as an income tax deduction, the expenses cannot form part of the property’s cost base for CGT purposes.

2. Expenses not incurred by the property owner, such as water or electricity charges paid by tenants.

3. Expenses that are not related to rental of a property, such as expenses connected to a property owner’s own use of a holiday home that is rented out for part of the year.Where a property is used for both private and income-producing purposes, a tax deduction cannot be claimed for the portion of any expenditure that relates to private use.

Prepaid rental expenses
Where a rental property expense is prepaid, say prior to June 2006 such as insurance or interest on borrowings, for a period that covers 12 months or less and the period ends on or before 30 June, 2007 an immediate income tax deduction can be claimed in the 2006 income year.

All prepayments of less than $1,000 can be claimed as an immediate income tax deduction in the same income year as the payment.

Non-commercial rents
Property, or part of a property, that is rented at less than normal commercial or market rates, may reduce the amount of deductions that can be claimed.

Rental deductions over a number of income years
Borrowing expenses in excess of $100 incurred for a rental property are claimed over the term of the loan or five years whichever is less. Borrowing expenses include the following:

• Loan establishment fees;
• Title search fees;
• Costs for preparing and filing mortgage documents, including mortgage broker fees and stamp duty charged on the mortgage; and
• Other costs imposed by the lender, such as the costs of obtaining a valuation or lender’s mortgage insurance where borrowings exceed a certain percentage of the property’s purchase price.

Interest expenses are not borrowing expenses.
Where the borrowing expenses are less than $100, the expenses are deductible in full in the income year when incurred.

2. Decline in Value of Depreciating Assets
A tax deduction may be claimed for an amount representing the decline in value of a depreciating asset that the property owner held for any period during an income year. Examples of depreciating assets include floor coverings, fixed heaters, hot water systems, curtains, shutters and cooktops etc.

However, this deduction is reduced on a proportionate basis to the extent that the asset was used for purposes other than that of producing assessable income, for example - the private use of a holiday home.

3. Capital Works Deductions
In the case of residential rental properties, capital works deductions are generally spread over a period of 25 or 40 years depending on a the type of construction and the date the construction started. The total capital works deductions cannot exceed the construction expenditure.

Construction expenditure is the actual cost of constructing a building, extension or alteration on a property owner’s land. This expenditure generally includes the component of payments that represents the profit made by individual tradespeople, builders and architects. However, where property including land is purchased from a speculative builder, the component of the payment that represents the builder’s profit margin cannot be claimed as a capital works deduction. Construction expenditure also includes payments for the cost of foundation excavations, retaining walls, fences and in-ground swimming pools.

Some costs that are not included in construction expenditure include the cost of the land on which the rental property is built, expenditure on clearing the land prior to construction and expenditure on landscaping.

Where ownership of the building changes and the new owner continues to use the building to produce income. The right to claim any undeducted eligible construction expenditure for capital works passes to the new owner.

Where a new owner is unable to determine precisely the construction expenditure associated with a building, an estimate provided by a quantity surveyor may be used. The quantity surveyor’s costs are tax deductible.

Summary
The Tax Act allows for deductions of expenses incurred in deriving rental income, but the Tax Office undertakes extensive audit activities to ensure that taxpayers do not claim more than they are entitles to.

If you are in any way unsure of what you can claim or wish to discuss your personal situation in more detail, please do not hesitate to contact Mark Hammerschlag on 9608 0165 or mhammerschlag@nexiaasr.com.au

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