Tax Time 2022: ATO focus on rental properties

We hope you enjoy our 2022 Tax Time content series.

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The ATO has issued a release notifying taxpayers that ‘income and tax deductions from rental properties’ is one of the four key areas the ATO is focusing on during Tax Time 2022. In particular, the ATO is concerned about the omission of rental income and deliberate over-claiming of rental deductions.

The ATO’s random enquiry program has found that 90 per cent of tax returns that reported rental income and deductions contain at least one error. This outcome is even though most rental property owners use a registered tax agent.

The ATO is urging rental property owners to ensure they carefully review their records before declaring income or claiming deductions, and for registered tax agents to ask a few extra questions of their clients.

We don’t expect agents to be Sherlock Holmes, but we do expect them to ask the right questions to ensure their client’s return is right.

– Assistant Commissioner Tim Loh

Note

Within the random enquiry program, the ATO randomly selects and profiles a sample of individual taxpayers who are not in business. Tax return data is matched to third party data. Verified taxpayers are not manually reviewed. The remainder of the sample progress to a review (the random enquiry program).

Include all rental income

The ATO receives rental income data from a range of sources including sharing economy platforms, rental bond authorities, property management software providers, and state and territory revenue and land title authorities.

Include all rental income, such as from renting out a holiday home, short-term rental arrangements and renting part of a home. Other rental-related income such as insurance payouts and rental bond money retained are also included.

Further, income and deductions must be in line with an owner’s interest in the property, which should generally mirror the legal documents.

Claiming correct deductions

It is critical to understand not only whether an expenditure is deductible but also when an amount is deductible.

Some expenses can be claimed immediately, such as rental management fees, council rates, repairs, interest on loans and insurance premiums.

Other expenses such as borrowing expenses and capital works are claimed over a number of years. Depreciating assets such as a new dishwasher or new oven costing over $300 are also claimed over their effective life.

Note

The cost of a depreciating asset is immediately deductible in the year incurred is available where:

    • the cost of the depreciating asset is $300 or less
    • the taxpayer uses the asset mainly for the purpose of producing assessable income that is not income from carrying on a business
    • the asset is not part of a set of assets the taxpayer starts to hold in the income year that costs more than $300
    • the asset is not one of a number of identical or substantially identical assets the taxpayer starts to hold in the income year that together costs more than $300.

Refinancing or redrawing on a rental property loan for private expenses such as holidays or a new car, means that the amount of interest relating to the loan for the private expense cannot be claimed as a deduction.

Rental expenses that are not deductible

A taxpayer cannot claim a deduction for the decline in value for assets in an existing residential rental property if the contract to purchase that property was entered into on or after 7.30 pm (AEST) on 9 May 2017.

Travel expenses related to a residential rental property are also not deductible. Travel expenses include the costs you incur on car expenses, airfare, taxi, hire car, public transport, accommodation and meals to:

  • inspect, maintain or collect rent for your rental property
  • travel to any other place as long as it is associated with earning rental income from your existing rental property (for example, visiting your real estate agent to discuss about your current rental property).

Where there is rental income from a holiday home, Assistant Commissioner Tim Loh’s advice is that:

You can claim expenses for the property to the extent that they are incurred for the purpose of producing rental income, not where your family and friends stayed in the property for a mini getaway at mate’s rates, you use it yourself, say at Christmas, or you stopped renting the property out.

Other circumstances in which deductions cannot be claimed include pretending that the property is available for rent when it really is not — for example by advertising significantly above a reasonable market rate or by placing unreasonable restrictions on potential tenants.

Selling a rental property

When a taxpayer sells a rental property, CGT needs to be considered.

If the property used to be the taxpayer’s home, they may be entitled to claim the main residence exemption in relation to part of the capital gain (or even the whole gain, depending on the application of the six-year absence rule).

It is also important to note that when selling any property for a contract price of $750,000 or more, vendors must obtain a ‘clearance certificate’ from the ATO and provide it to the purchaser, otherwise 12.5 per cent of the consideration will be withheld by the purchaser — and remitted to the ATO — under the foreign resident capital gains withholding rules.

Tip

Clearance certificate applications can take up to 28 days to process so to avoid delays, sellers should apply as early as practical using the online form. Having tax affairs up to date, including all lodgments, helps speed up the assessment of an application and a certificate being issued.

Good record keeping

Records of rental income and expenses should be kept for five years from the date of the lodgment of the relevant tax return or for five years after the disposal of the property, whichever is longer.

Adequate records should demonstrate how the expense was incurred and the extent they relate to producing rental income. They must include the name of the supplier, amount of the expense, the nature of the goods or services, the date the expense was incurred, and the date of the document.

Most common mistakes

The random enquiry program found that the rental component of the individuals not in business net tax gap is estimated at $1.5 billion. The most common reasons for tax return adjustments to rental items are a lack of, or incorrect, apportionment of expenses. The ATO also sees mistakes relating to capital works and capital allowance deductions.

The ATO has provided some rental deductions tips for tax practitioners assisting their clients:

  • apportion deductions according to the share of ownership
  • taxpayers can only claim expenses for a rental property that are incurred in producing rental income
    • check if there are any periods when the property wasn’t being used to produce income
    • ensure deductions for the property expenses are reduced for periods your clients
      • use or reserve the property
      • allows friends or family to rent it at mates rates
      • have unreasonable conditions on the property
  • record deductions for each rental property separately
  • check if repairs or maintenance should be capital works that need to be claimed over a period of time
  • set up a depreciating asset schedule to keep track of certain items.

In addition, if the taxpayer has updated their mortgage over the rental property, the practitioner should ask them if the loan also covers personal items and purposes — if so, the interest expenses need to be apportioned.

Tax Time toolkit for investors

As part of its Tax Time suite of guidance, the ATO has released the Tax time toolkit for investors for 2022. The fact sheets relating to rental properties include:

References – More information

ATO fact sheet Residential rental properties.

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