Borrowing costs are an often overlooked but significant expense that investors can claim as a tax deduction. Under Section 25-25 of ITAA 1997, borrowing costs are deductible over the shorter of the loan term or five years. These costs include loan establishment fees, title search fees, and mortgage document preparation fees. However, they do not include the principal borrowed or interest payments.
A common misconception is that these costs can be claimed in full in the year they are incurred. Instead, they must be spread over time, which can influence your cash flow and tax planning strategies.
To see how this plays out, consider a scenario where you purchase a residential investment property in Melbourne for $800,000. You incur borrowing costs totaling $5,000, including a loan establishment fee and legal costs. If your loan term is 20 years, you would claim $1,000 per year over five years, reducing your taxable income. At a 37% marginal tax rate, this results in a tax saving of $370 per year.
In our experience reviewing thousands of properties across Australia, many investors fail to account for all eligible borrowing costs, missing out on potential tax savings. Others mistakenly claim these costs upfront, leading to ATO audits and potential penalties. It's also common to overlook refinancing costs, which can often be claimed as well.
The answer can differ depending on your situation. If your borrowing costs are under $100, you can claim them in the first year. For properties acquired before 1 July 2017, different rules apply if they were second-hand. Also, for properties held in an SMSF or by a company, specific rules and limitations might affect your deductions.
Given these complexities, it's crucial to consult a Chartered Quantity Surveyor and your accountant. They can ensure you capture all eligible deductions while complying with the latest tax laws.