There are not many things as nerve-wracking and stressful as when the ATO comes knocking and demanding to see your books. To prepare you for such an event, Angelo Panagopoulos lists some practical and time-tested strategies1. Be meticulous with your record-keeping
Keeping good records, as well as keeping your accountant’s fees to a minimum, will minimise your risk if there is an ATO audit, especially if you can substantiate and verify all your income tax deductions and assessable income.
Also, as capital gains tax may apply if you sell your investment property, it is prudent to keep records of all the costs and transactions associated with the property, such as contracts of purchase and sale, conveyancing invoices and settlement statements, loan records and documentation, documentation relating to capital improvements and
initial repairs, and so on.
2. Claim borrowing expenses the right way
The correct way to claim borrowing expenses of more than $100 is to amortise (similar to depreciation) the income tasx deduction over a five-year period. If the borrowing expenses are less than $100 for the year, you can claim the full tax deduction in the income year when it was incurred. If you claim your borrowing expenses as an income tax deduction, you cannot include them in your cost base for capital gains tax purposes when you dispose of the property. if the loan is less than five years, you can claim the unamortised portion in the income year when the loan is settled and finalised. A common mistake is to claim all the deductible mistake is to claim all the deductible borrowing expenses in the first year they are incurred.
When claiming initial repairs and capital improvements, keep the following in mind. Initial repairs to rectify damage, defects or deterioration that existed at the time of purchasing a property are capital expenditure and may be claimed as capital works deductions over either 25 or 40 years, depending on when the repairs were carried out. Capital improvements, such as renovating a kitchen, bathroom or adding a pergola, should also be claimed as capital works deductions. A common mistake is to claim initial repairs or capital improvements as immediate deductions.
3. Know which expenses can be claimed legally
Legal expenses such as conveyancing expenses incurred on the purchase and sale of your property are not deductible. Rather, legal fees and conveyancing expenses form part of the cost base for capital gains tax purposes.
4. The purpose of your loan determines whether you can claim interest rate expenses or not
Regardless of which property you use as security to obtain the loan
(for example, your principal place of residence or your investment properties or a combination of both), if the purpose of the loan is not for investment purposes (for example, you may use an investment property as security to purchase your newly upgraded principal place of residence, but the purpose of this loan is private in nature as the loan is being used to fund your private home), then although an investment property is used as security, the interest on the loan in this example is not deductible.
Also, if you use a loan facility for both investing and private purposes, apportionment of the interest expense as a tax deduction must be calculated because you cannot claim the interest expense on the private portion of the loan. Please note: if you use a loan facility for mixed purposes, it is very important that you have very good record-keeping in this area.
5. Be careful when claiming travel expenses
Where travel related to your investment property is combined with a holiday or other private incidental activities, you must apportion the travel expenses directly related to inspecting/visiting your investment property. For example, if you are travelling interstate to inspect your interstate investment property for one day and then spend a further four days on a holiday, then you must apportion and claim 20% (one day divided by five days) of your travel costs, accommodation, etc. A common mistake is to claim a deduction for the cost of travel when the main purpose of the trip is to have a holiday and the inspection of the property is incidental to that. Additionally, it is prudent to keep a travel diary to further substantiate your travel claims as tax deductions.
6. You may not be able to claim the full value of scrapping
If you intend to renovate a kitchen, bathroom, bedrooms and so on in your investment property, you may be able to claim a scrapping value on your old bathroom, kitchen, bedroom, etc., provided they have already been used for income-producing purposes. However, further apportionment is required and you must know the investment property’s prior history of use by previous owners, especially if any part of the prior use of the property was for private purposes. Just because your investment property has been used (while you have been the owner of the property) for income-producing purposes prior to scrapping does not necessarily mean you can claim the full value of the scrapping as a tax deduction.
7. Be clear about ownership interests
A common mistake occurs when a property is purchased by a husband and wife as co-owners (or alternatively as unit holders in a unit trust and/or as common shareholders in a company) and the income and expenses are not shared in line with their respective legal interest in the property.
8. Capital gains tax concessions
The 50% capital gains tax discount concession (if the property is held in individual names and/or a trust) only applies if you have held the property for at least 12 months. A common mistake investors make is to assume this applies from the settlement date. The 12-month holding period rule applies to contract dates, so caution must be used in this area.
9. Beware of the downsides of a trust structure
Due to asset protection and estate planning purposes, many property investors hold their properties in trust structures. If the incorrect type of trust structure holds the property, then the tax losses are locked in the trust itself and cannot be utilised by the individual taxpayer.
10. Be clear about your profit intention
If you intend to purchase a property to improve and then resell it as a profit-making venture, then this is a business venture and, along with the fact that GST may be applicable, there is no entitlement to the 50% capital gains tax discount concession either.
11. Property seminars
Educational property seminars and/or courses offered by buyers’ agents and/or property experts are not tax deductible. Advice on how to purchase an investment property is not tax deductible, even if they say that it is. Only tax advice from a registered tax agent is generally tax deductible.
12. Stamp duty
Stamp duty incurred when you purchase a property is not an allowable tax deduction. This forms part of the cost base of the property and can be factored in when calculating your capital gains tax position when you sell your investment property in the future.
Angelo Panagopoulos is principal at Hamilton Reid Chartered Accountants, specialising in property and taxation, asset protection and ownership structures.
