Rental Expenses: Residential Rental Property Tax Deduction Guide

Property is red hot at the moment. Many people managed to save more money during Covid lockdown by not going out and spend big on property purchase and home renovation instead. First time property owners often ask: what rental expenses can we claim? It can be quite confusing as what rental expenses you can claim or to what extend you can claim.

Rental Expenses: What you can claim

You can claim tax deduction for certain expenses incurred for the period your property is rented or is available for rent. However, if the rental expenses are capital in nature, you won’t be able to claim an immediate tax deduction. If the property is only rented out part year, you need to apportion the rental expenses.

First, let’s have a look what rental expenses you can claim immediately. You can claim a deduction for these expenses only if you actually incur them:

• Mortgage interest on loans
• Borrowing costs (different rules apply)
• Council rate
• Water charges
• Body corporate fees
• Land tax
• Insurance – building, contents, public liability and landlord insurance
• Advertising for tenants
• Property agent management fees
• Bank charges
• Cleaning
• Pest control
• Utility costs
• Legal expenses in relation to lease
• Lease costs – preparation, registration, stamp duty
• Mortgage discharge expenses
• Quantity surveyor’s fess to prepare depreciation schedule
• Servicing costs such as servicing for swimming pools or water heaters
• Telephone calls, stationery and postage
• Repairs and maintenance providing they are not initial repairs
• Book keeping fees

Borrowing costs

Many people incur mortgage insurance while purchasing investment properties. Unfortunately you can’t claim the entire mortgage insurance cost in one go. Instead, you can claim the mortgage insurance expenditure over the period of 5 years.

If you incur any other small borrowing cost for the total of less than $100, you can then claim an immediate deduction.

Repairs

Repairs Vs Improvement.

You can claim deductions on repairs you make to the rental property. However, the repairs must be directly related to wear and damages as a result of renting out the property. Repairs generally involve replacement of a worn out part. For example replacing a damaged part inside of an air conditioning unit is a repair. On the other hand it’ll be different, if the entire air conditioning unit is damaged beyond repair and you bought a new one to replace the whole thing. In this case, you won’t be able to claim the cost of the new air conditioning as immediate deduction. But you can claim the depreciation deduction for a number of years.

Improvement involves replacement of an entire structure or unit of the rental property. Generally speaking most major renovations such as replacing the whole kitchen cupboards or bathroom shower suite are improvements. As a result of conducting rental improvements, you’ll only be able to claim those costs over the 40 year period. This will be discussed further more later.

Initial repairs

According to ATO, the price you pay for the property takes into account any repairs required immediately to get the property to earn an income. This means that you can’t claim deductions costs of repairs carried out to rectify defects that existed when you purchased the property. It is also the case if you weren’t aware of the defects at the time of purchase. You can however, include all the initial repair costs as part of your cost base of the property upon disposal of the property.

Repairs when property is no longer available for rent

You may still claim rental deductions on some of the repairs if the property is no longer available for rent. For instance, if the repair is related to the period in which the property was used to produce income. You must carry out the repairs by 30 June during the income year that the property was producing an income.

Interest on loans

Many home owners want to claim interest on their home loans as tax deductions. But, you can’t claim that as your work related expenses in your tax return. If you take out a loan to purchase a rental property, you can claim the interest charged on that loan. Sometime, you need to apportion the interest as a tax deduction. However, the property must be rented or available for rental. You can’t claim any interest expenses if you use the property for private purposes.

If you take out a loan to purchase land on which to build a rental property you intend to rent out, you can claim the loan interest as a tax deduction. On some other occasions, you might take out a loan to renovation a property that you intend to rent out. Like wise, you can claim the loan interest in this case.

Also, while the property is available for rent, you may claim interest on loans for:

• Purchasing depreciating assets (assets over $300)
• Renovations
• Repairs

You won’t be able to claim the total costs of depreciation assets as immediate deductions but we’re going to discuss that in details the next.

Claim deductions over a period of time

When you purchase items that each cost more than $300 for your rental property, you can’t claim immediate deductions. However, you can claim the costs over a period of time during the life expectancy of the items. In other words, you can claim depreciation ductions on those items over $300. According to ATO, you’ll be able to claim a percentage of the cost each year until the cost is all written off.

There are two parts of depreciation costs you can claim. Once is deprecation on plant and equipment. The other one is Capital Works deduction.

Depreciation on plant and equipment

Be aware, there have been some changes to depreciation deductions on plant and equipment in recent years. From 1 July 2017, depreciation deductions on plant and equipment are only available on expenditure incurred on brand new assets. In simple terms, property plant and equipment items are those fixtures and items you can easily remove from the property. Dishwashers, ceiling fans are all common examples for plant and equipment. If you bought a fully renovated order property, you can’t claim any deprecation deductions on those new fixtures and fittings installed by the seller. 7:30pm (Australian Eastern Standard Time) on 9th May 2017 is the cut off time. If you purchase a property previously owned by someone else, rules are different on whether or not you can claim depreciation deductions on plant and equipment which was already in the property.

If you purchased or entered into a contract to purchase a rental property before that time, you can claim deductions for depreciation on assets purchased with the property. After that time, you can’t claim those deductions any more. However, you can still claim depreciation deductions on new plant and equipment you buy after purchasing the property.

Capital works deduction

Whether you by a new property or not, you can always claim building depreciation on the actual cost of the building. Note, the cost of the building is not your full purchase price. The depreciation rate on cost of the building is usually 2.5% per year. As a general rule, any residential building where construction commenced after the 15th of September 1987 will entitle their owner to capital works deductions at a rate of 2.5 per cent per year for up to forty years. Property investors can claim deductions for the periods that the property was rented or available for rent.

As mentioned above, costs of rental improvements are not available for immediate deduction. They are added to the capital costs of the properties and maybe claimed under capital works deduction. Other common examples of improvements include extensions, building a new fence, replacing the whole roof etc. Plumbing works can be tricky as most rental report from real estate agent will simply state them all as plumbing. In those cases, you’ll need to delve into more details. For example, if the whole toilet bowl was replaced, it’ll be capital works and you’ll only be able to claim the costs over 40 years. If it’s a job of replacing the whole hot water system, you’ll be able to claim the whole costs over the effective life of the hot water system, usually 10 – 20 years. You can claim immediate deductions if the whole plumbing bill only contains labor costs in fixing blockage issues or replacing  a section of pipes.

Prepayment of rental expenses

You can claim an immediate deduction on prepayment of some rental expenses such as insurance and mortgage interest. Conditions are that your prepayment covers a period of 12 months or less and the periods ends on or before 30 June of any income year.

What you can’t claim as rental deductions

• Cost of buying and selling your rental property, such as:
• Stamp duty on purchase
• Legal costs for property purchase
• Real estate agent’s fees on sale
• Buying agent fees
• Survey fees for purchase
• Interest paid on property while it’s not available for rent
• Initial repairs as we mentioned above
• Travel expenses for purchasing and inspecting rental properties after 1 July 2017, unless you are carrying on a business as a rental property investor.

Record keeping requirement

Of course, record keeping is very important to substantiate your rental expenses deductions. You need to keep the records in relation to rental expenses for 5 years from the tax year they are claimed in. If you are claiming depreciation, you need to keep the receipts for 5 years from the last year of claim.