Rental Income

Thinking of owning an investment/rental property or maybe you already own one but you’re not sure about the treatment of transactions when it comes to tax time? Well, this one’s for you!

What do we mean by ‘rental property’?

A rental (or investment) property is basically a property owned by you that generates income through a contract of lease to someone else - someone who lives in your house and pays you rent. It can actually be rented out in any form, as long as the owner is having an inflow of money from it.

The thing is, rental income is not ‘free money’. The ATO is going to tax you on it, so we need to be clear about what rental income is and what deductions you can claim against it to bring the taxable income down and  reduce your tax bill too!

 

Rental Income

This one is pretty easy - keep track of all monies your lessee is meant to pay to you and what they actually did pay to you for the financial year. 

 

Rental Expenses

You can claim a deduction for the costs you incurred in relation to earning rental income, but naturally there are some rules around what and how much you can claim, and of course you need to keep good records. 

 

What records do we need to keep?

In the tax return, there’s actually a rental property schedule to complete - like a worksheet. For everything you report in there, you need to keep the supporting documents. 

 

Here’s a list of the property information/documents that you need to prepare for your accountant:

 

• Conveyance and loan documents

• Contracts of purchase and sale

• Land tax assessment

• Bank statements and credit card records

• Tenant leases

• Rent records from managing agents

• Address town, city, state, postcode, country

• Date first earned rental income ever

• Number of weeks it was rented this year

• Number of weeks it was available for rent this year

• Percentage of the property that you own

• Acquisition date

• Acquisition value

• Rental income per period

• Expenses incurred for the property (receipts)

 

 

For the once off documents, like purchase contracts and lease agreements, we recommend you keep a copy of all of these in the Google Drive folder that you share with us. 

For the income, your accountant wants to see the lease agreement as well as the bank statements showing the money received.

For the deductions, your accountant wants a spreadsheet showing all transactions, the bank statements ideally, and the receipts for everything please. We get our clients to upload it to the Google Drive folder for safe keeping. 

 

Here are some of the expenses that you can claim:

Advertising for tenants 

• This is basically the advertising/marketing expenses you incur to attract potential tenants, this is typically charged by your real estate agent.

 

Body corporate fees and charges

• Body corporate fees are for common/shared areas on Strata Titled properties such as condos/apartments/units. For example getting the elevator in your building fixed. As a rule of thumb most Strata Corporations will charge a fixed quarterly amount rather than charging for the services.

 

Council rates

• This is property tax in general. This is paid to fund the services provided by the government such as maintenance of local roads, council facilities and public spaces.

 

Water charges

• Water bills/charges for the rental property.

 

Land tax

• Annual or quarterly, tax owners pay to state and territory governments based on the value of the land they own.

 

Cleaning 

• Paid to maintain the cleanliness of the investment property.

 

Gardening and lawn mowing

• If you have put a lot of work into the garden, and you want to keep it that way, it’s not a bad idea to pay for gardening. This is also a good way to attract potential tenants.

 

Pest control

• We don’t want unwanted pests roaming around our property. Pest control also is a deductible expense for your investment property. 

 

Insurance

• This is typically known as a landlord’s policy and it’s usually a bit cheaper than a regular home policy.

 

 Interest expenses

• Interest expenses occur when you take out a loan for the purchase of your rental property. These charges can also be claimed when you’re charged on a loan you used to finance renovations, make repairs (example: roof repairs), and for the purchase of depreciating assets for the property.

 

Note: The general rule is you can claim a deduction for interest expenses relating to the rental/investment property. If the property/asset is being used for private purposes, then interest expenses incurred in that period can no longer be deducted for tax purposes. If the purpose is shared (part personal, part investment) then only claim the appropriate amount of total interest. Keep in mind that capital gains can be an issue later. 

 

Prepaid expenses

• These are expenses incurred for services extending beyond the current income/financial year. One example of this is insurance premium on the first day of the year that covers the payment for the entire calendar year.

 

You can claim a deduction for prepaid expenses of:

 

• less than $1,000 

• $1,000 or more where the service period is 12 months or less

 

 

You may have to spread the expenses to over two or more years if the prepayment incurred does not meet the criteria stated above.

 

Property agent’s fees and commission

• These expenses actually relate to the marketing of the property itself. Agents help in looking for potential tenants who can occupy the property. 

 

Repairs and maintenance 

• As long as the repairs and maintenance is for the property being rented, you may be able to claim in full the expenses incurred. 

 

What is the difference between repair and maintenance? When something gets broken or stops working, repair is done for the restoration of the latter. While maintenance are the necessary procedures/routine done to prevent the damage of the property.

 

Improvements

• These are the alterations/improvements done to the property. It includes shop fitouts and leasehold improvements. 

 

Examples of improvements:

 

• Embankments

• Shop fitouts

• Leasehold improvements

• Driveways

• Fences

• Walls

 

 

Some legal expenses

 

Here are some costs that can be included as a deduction for rental properties:

• evicting a non-paying tenant

• expenses incurred in taking court action for loss of rental income
• defending a damages claim regarding injuries suffered by a third party on your rental property.

 

These are the costs that you can’t claim as tax deductions:

• solicitor's fees for the purchase of the property 
• solicitor's fees for the preparation of loan documents
• legal costs associated with resisting land resumption 
• legal costs associated with defending your title to the property (for example, defending an action by the mortgagee to take possession of the property where you have defaulted under the loan – these are a capital expense)

Capital expenditure

• These are expenditures of an organization to purchase, maintain, or improve its fixed assets, such as buildings, vehicles, equipment or land.
• This can also be broken down into two concepts: 
• First is you can think of it like a Plant & Equipment. Examples are: air conditioning units, hot water system and oven. Plant & Equipment is depreciated over its useful life. The ATO provided a guide each year for the depreciation of each. You can ask the guidance of your accountant for that. 
• Second is Capital works: Driveway paving, fences, retaining walls etc.The main difference between the two is Plant & Equipment can easily be pulled out and sold while capital works are already attached to the property once it’s installed. Capital works are depreciated either at 2.5% or 4% depending on the type of work done.

 

Your accountant would love you to provide a depreciation report from a quantity surveyor - if you don’t have one we recommend getting one because you could be missing out on deductions. A quantity surveyor can estimate the depreciable value of the plant & equipment and capital works so you can claim a depreciation even if you don't have receipts. 

 

Case Studies and Frequently Asked Questions:

 

What if you only own part of the property? (50% owned by you and 50% owned by your brother)

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Both you and the other owner need to record information about the property in your individual tax returns, assuming you hold the ownership in your own name and not via a Trust or other entity. 

Since only half of the property is owned by you, only half of the income and expenses would be apportioned to be filled on your tax return. 

Let’s say the property earned a rental income of $50,000 and incurred expenses of $15,000, making the total rental income $35,000. Income and expenses would be apportioned to 50% to both of you, which would also result in a net rental income of 50% to both of you You get taxed on $17,500.

What if you and your brother took a loan for the rental property?

• Loan amount of $100,000 from which $25,000 is to be used to purchase the new car of your brother.
• You also incurred an interest expense of $10,000.

How much interest expense can you claim as a deduction?

Since the loan is intended not only for the rental property but also the purchase of a new car, you must do the following computation to work out the interest for the rental property alone:

Total interest expense x (rental property loan divided by total borrowing) = deductible interest

 

That is:

$10,000 x ($75,000 divided by $100,000) = $7,500

 

As a result, you can claim $7,500 as an allowable deduction for tax purposes.

What if I own the property and live in it, but rent out a room?

This one’s interesting and a bit tricky. Take note, rental income exists as long as either the whole property or part of the property is being rented.

Let’s say you own the property outright (no mortgage), and earn rental income of $30,000 for the room, and incurred expenses of $8,000 for the period it was rented. We need to include all of this info in your return, and you will be taxed on the $22,000 net rental income. 

Note: this means part of your property is income-generating (so is part investment and not your private property) so might result in capital gains issues down the track. More on that later! 

Here’s a more complicated scenario…

Assuming you took a loan of $400,000 for the purchase of the whole property and your total interest expense was $5,000 per year.

How much interest expense can you claim for the room being rented out?

The best thing to do is to grab the floor plan of the property. You can make a percentage based on the size of the room being rented out.

 

Example:

Whole property size - 500 sqm

Room being rented out - 100 sqm

 

Total interest expenses x (room being rented out divided by whole property size)

 

That is:

$5,000 x (100 sqm divided by 500 sqm) = $1,000

 

Therefore, you can claim $1,000 as an allowable deduction in this financial year.

What if I was living in the property (not renting it) and now I live elsewhere and rent it out 100% to someone else?

When you start renting out the property, then we start including that in your tax return for the ATO. 

The computation of interest for the loan, if any, still applies to the whole amount of loan but the interest expense that is claimable as a deduction only applies to the period when the property was rented out.

Let’s say there’s a loan amount of $400,000 for the property that you purchased and your total interest expense is $35,000 over the properties lifetime, and about $5,000 per annum. For this financial year, you lived in the property for 8 months and for the remaining 4 months you transferred to a different house and decided to rent out the property.

In the above scenario you would do the following calculation:

 

Total interest expenses x (months the property was rented out divided by months in a year)

 

That is:

$5,000 x (4months divided by 12 months) = $1,667

You can claim an amount of $1,667 as interest expense for the rental property.

 

What if I was renting it out and now I live in it?

Same rules apply to this from the example above, but the opposite! You can claim a portion of the interest, related to the period it was rented out and you cannot claim the rent related deductions after you stop renting the property to others.