Repair vs Maintenance vs Improvement

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Many taxpayers confuse the difference between repairs, maintenance and improvement. They are tax deductions but are treated differently for tax purposes. Here are the differences:

Repair

Repair is work to resolve wear and tear to the property to bring it back to its original condition. E.g. Replacing part of a fence, fixing a crack in the plaster, patching a roof, repairing a malfunctioning piece of machinery

Maintenance

Maintenance is work to prevent deterioration in the condition of an asset. E.g. Repainting walls, maintenance plumbing

Improvement

Improvement is increasing the value of the property by enhancing the item beyond its original state at the time of purchase. This would either be classified as a capital works deduction or a capital allowance deduction.

Capital works: Deductions relating to building’s structure and items fixed to it. These are claimed at a rate of 2.5% per year for 40 years following construction. E.g. retiling the bathroom, replacing all the fencing, major renovations, adding a fence

Capital allowance: Deductions that can be easily removed from the property. These are claimed over the effective life the Commissioner has determined or your own reasonable estimate of its effective life. E.g. Replacing a light fitting in the bathroom, installing a new carpet, installing, new curtains

There are exceptions to this. When you first purchase an investment property, you may need to carry out repairs before renting it out. These are known as ‘initial repairs’ and will be added to the cost base.

If you are still confused about the distinction, please contact our office at 03 9973 5905.

How does Negative Gearing Work?

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Negative gearing is a popular investment strategy used by many individuals to reduce their taxable income. It involves borrowing money to invest in an asset that generates an income lower than the cost of owning and maintaining it. The most common asset types that people use negative gearing for include property, shares, and managed funds.

The ATO allows taxpayers to claim deductions for the expenses incurred in holding a negatively geared investment property, such as interest on the loan, council rates, and property management fees. These deductions can be offset against the rental income generated by the property, thereby reducing the taxable income and the amount of tax paid by the taxpayer.

However, negative gearing also has its risks. In the case of property investment, for example, investors may face difficulties in finding tenants, maintaining the property, or covering the mortgage repayments during periods of vacancy. Moreover, negative gearing relies on the expectation that the value of the asset will increase over time, allowing investors to sell the property for a profit in the future. This assumption is not always accurate, as property prices can fluctuate and may not always rise.

An example of negative gearing in action would be an investor who buys an investment property for $500,000, financed with a loan of $400,000. The investor earns $20,000 in rent for the year, but incurs $30,000 in expenses, including interest on the loan, property management fees, and repairs. The net loss for the year is therefore $10,000. This loss can be offset against the investor’s other income, such as salary, reducing their taxable income and the amount of tax they pay.

In summary, negative gearing can be a viable investment strategy for those seeking to reduce their taxable income, but it also carries risks and requires careful consideration of the costs and potential returns. If you would require more assistance on this matter, please contact our office at 03 9973 5905.

Capital Gains Tax on Inherited Properties

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When a property is inherited, the recipient is considered to have acquired the property at market value at the time of the inheritance. If the recipient decides to sell the property in the future, they may be subject to capital gains tax.

Capital gains tax is calculated by subtracting the cost base of the inherited property from the sale price. The cost base includes the market value of the property at the time of inheritance, as well as any additional costs such as renovations, repairs, or improvements.

If the inherited property was rented out, there are additional factors to consider. If the property was generating rental income, the recipient may be subject to income tax on that rental income. Additionally, the rental income may affect the cost base of the property, as any expenses related to the rental property can be used to offset capital gains tax.

For example, let’s say John inherited a rental property from his father in 2010. At the time of inheritance, the property was valued at $500,000. John decided to rent out the property and has been receiving rental income of $20,000 per year.

In 2021, John decides to sell the property for $800,000. His cost base includes the market value of the property at the time of inheritance ($500,000), as well as any additional costs such as renovations ($50,000). His total cost base is $550,000.

The capital gain on the property is therefore $250,000 ($800,000 – $550,000). John will be subject to capital gains tax on this amount. He may also be subject to income tax on the rental income he received over the years.

It’s important to keep thorough records of any expenses related to the inherited property, as these can be used to offset capital gains tax. If you inherited a property and would like more assistance on this matter, please contact our office at 03 9973 5905.

Holiday Homes

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If you own a holiday home, you may be eligible to claim certain deductions on your tax return. However, the ATO has specific rules and regulations regarding claiming deductions on holiday homes.

To claim deductions on your holiday home, it must be rented out to tenants for at least part of the year. The amount of deductions you can claim will depend on the amount of time the property is rented out and the expenses associated with maintaining the property.

Expenses that can be claimed as deductions include:

  • Interest on the mortgage
  • Council rates and land tax
  • Insurance premiums
  • Repairs and maintenance
  • Cleaning fees
  • Advertising costs to find tenants
  • Property management fees

However, if you use the holiday home for personal use, such as a family vacation, you cannot claim any deductions for that period. In addition, if the property is not available for rent for a significant period, such as being blocked out for personal use, the deductions may be limited or disallowed.

It’s important to keep accurate records of all income and expenses related to your holiday home, as well as evidence that it was available for rent during the times you are claiming deductions for.

Here’s an example of how claiming deductions on a holiday home might work:

Emily owns a holiday home in a popular tourist destination. She rents out the property for 6 months of the year and uses it for personal use for the remaining 6 months. During the rental period, she earns a total of $20,000 in rental income. She also incurs expenses for the property totalling $15,000, including interest on the mortgage, council rates, insurance premiums, repairs and maintenance, cleaning fees, advertising costs, and property management fees.

Emily can claim deductions for the $15,000 in expenses, which will reduce her taxable rental income to $5,000. She cannot claim any deductions for the 6 months she used the property for personal use.

If you own a holiday home and need tax advice, please contact our office at 03 9973 5905.

travel deductions

Travel deductions to and from rental premises no longer allowed

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If you own residential premises that you rent out, you should be aware that you may no longer be able to claim travel deductions connected with trips you make to and from those premises.

Travel expenditure incurred on or after 1 July 2017 in connection with residential premises from which you earn rent or other assessable income will not be deductible (subject to certain exceptions – see below). This includes expenses for travel undertaken to, for example, collect rent, inspect, or maintain the premises.

The measure was originally announced in May as part of the 2017–2018 Federal Budget. We now have legislation that will implement this.

“Travel expenditure includes motor vehicle expenses, taxi or hire car costs, airfares, public transport costs, and any meals or accommodation related to the travel”

Some workplaces require their staff to wear a uniform. Or if you’re a tradie, you will be required to wear steel capped boots, heavy duty protective clothing and other items. You could claim:

  • Uniform
  • Laundry
  • Protective shoes or non-slip shoes
  • Safety equipment and protective clothing
  • Sunglasses and sunscreen.

It does not matter where the residential premises are located. For example, if you travel by car to mow the lawn of a house you rent out, you will not be able to deduct those car expenses. Similarly, if you fly interstate for a couple of days to inspect an apartment you rent out and you stay in a hotel, you will not be able to claim a deduction for your flights, hotel, meals and taxis (eg, to and from the airport or from the hotel to the apartment).

There are a number of exceptions to this, which are as follows:

  • if the expenditure is incurred in carrying on a business (eg, if you own many residential rental premises and you are treated as carrying on a business);

  • if the expenditure is incurred by a company;

  • if the expenditure is incurred by a managed investment trust or a public unit trust;

  • if the expenditure is incurred by a superannuation fund – but this exception does not apply if the fund is a self-managed fund (SMSF), so travel expenditure incurred by an SMSF will not be deductible.

If the residential rental premises are owned by a partnership, the travel expenditure will not be deductible unless all members of the partnership are one of the excluded entities listed above – ie, a company, managed investment trust, public unit trust or superannuation fund that is not an SMSF.

You should also be aware that any travel expenditure that is not deductible will be ignored in working out your capital gain (or loss) should you sell the premises – in other words, the expenditure cannot reduce the capital gain (or increase the loss).

The changes will not prevent you from engaging third parties such as real estate agents to provide property management services for an investment property. These expenses will remain deductible.

Other restrictions

There are two other related measures that were announced in the Federal Budget:

  • limiting depreciation deductions for second-hand depreciating assets used or installed in residential rental premises; and

  • imposing an annual vacancy fee on foreign owners of residential property that is not occupied or genuinely available for rent for at least six months in a 12-month period.

Do you rent out residential premises?

If you rent out residential property that you own, please contact our office for further information on what is deductible from the tax you may owe.

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Renting out your holiday home

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A holiday home is a common investment for many Australians. Often the holiday home is rented out for part of the year to help finance the cost of owing the property or just to provide an additional source of income. The rent received must be declared in the owner’s tax return as income against which related expenses can be claimed as tax deductions. In this article we cover some of the essentials in claiming holiday home rental expenses.

What can be claimed as a tax deduction?

As with traditional rental properties most expenses incurred in running a holiday home may be deductible. These include:

  • Advertising costs

  • Agents fees and commissions

  • Body corporate fees

  • Council rates

  • Depreciation on assets and buildings

  • Insurance – building/landlord

  • Interest on funds borrowed to acquire the property

  • Land tax

  • Repairs and maintenance

  • Water rates

  • And more

When are these expenses deductible?

The most common mistake when accounting for holiday homes in a tax return is claiming expenses for the entire year.

Expenses are only deductible where the property is rented out or when it is genuinely available for rent even if it is not rented at that time. Therefore, expenses incurred when the property is used for private purposes or while it is not genuinely available for rent are not claimable.

Private purposes include periods where it is used by the owners or the owners’ family or friends for free. Genuinely available for rent means the owner is making a bona fide attempt to rent the property and that it has a realistic chance of being rented. Factors that suggest it is not genuinely available for rent include:

  • Only using advertising that has limited exposure (such as word of mouth)

  • Only making the property available at low demand times (i.e. when it is unlikely to be rented)

  • Poor property condition

  • Poor location and accessibility that make rental unlikely

  • Placing unreasonable conditions on renting the property

  • Asking for an unrealistic rental amount

How to calculate deductions correctly

Where a holiday home is used to genuinely produce rental income during a year, but is also used for private purposes or has periods where it is not genuinely available for rent, expenses must be apportioned. Generally, this is done on a time basis. For instance, where a holiday home is rented for 3 months and not available for rent for the other 9 months, 25% of expenses, representing 3 months out of the entire year, will be deductible.

Expenses that relate directly to rental income such as advertising and agents commission do not need to be apportioned.

Where the holiday home is rented at below market rates to a related party, the deductions for that period are limited to the rental income received in that period.

Is the sale of a holiday home subject to capital gains tax?

In most cases, a holiday home will be subject to capital gains tax. This is because generally the owners will claim the main residence exemption on another property (such as their home). However, in addition to purchase, selling and capital costs, expenses incurred in holding the property that could not be claimed as tax deductions will also reduce any capital gain. These include rates, land taxes, insurance and repairs while the holiday home is not rented or available for rent. For this reason, it is important to keep records for all holiday home expenses for the entire period of ownership.

For more information on this topic, or for assistance with correctly declaring your holiday home, contact our team at Private Wealth Accountants.