The ATO has sharpened its focus on rental property deductions, recognising this as an area where compliance issues frequently arise. They are particularly vigilant in scrutinising claims related to interest expenses, repairs, and depreciation, ensuring these are substantiated and accurately represented according to the tax legislation.
Under Division 40 of ITAA 1997, the ATO examines deductions for plant and equipment, ensuring investors do not claim depreciation on second-hand assets acquired post-9 May 2017, unless grandfathered. Division 43 covers capital works deductions, where the ATO checks if claims align with the building's construction date and the appropriate depreciation rates. A common misconception is that all property expenses are deductible immediately, but the ATO differentiates between repairs and improvements, the latter needing to be capitalised.
To see how this plays out, consider a 2010-built 3-bedroom house in Perth purchased for $750,000. Suppose the owner claims interest deductions on a loan used to purchase the property. The ATO will scrutinise whether the loan was indeed used for income-producing purposes. If the owner also claims repairs, the ATO will differentiate between repairs (deductible immediately) and improvements (depreciated over time). At a 37% marginal tax rate, correctly classifying and claiming deductions could save the owner $5,000 in taxes annually.
In our experience reviewing thousands of properties across Australia, we often find that investors overlook the importance of maintaining thorough records. Another frequent issue is misclassifying capital improvements as repairs, leading to incorrect immediate deductions. Many investors are unaware of the need to adjust depreciation schedules for assets disposed of or no longer in use. Additionally, interest deductions are often incorrectly claimed for personal portions of loans. Lastly, we notice a lack of understanding of how to apportion deductions for properties used partially for private purposes.
The answer can differ depending on your situation. For properties acquired after 9 May 2017, claiming depreciation on second-hand plant and equipment is restricted. Pre-1987 buildings have different capital works eligibility. Joint ownership means deductions must be apportioned according to ownership interest. If a property is used for both rental and private purposes, deductions need careful apportionment. Commercial properties follow different rules, particularly regarding capital works deductions.
Given the complexities, professional advice is crucial. A Chartered Quantity Surveyor can ensure depreciation schedules are accurate and compliant, while an accountant can provide guidance on the correct apportionment of expenses and ensure all claims are substantiated.