Initial Repairs and claiming deductions
When purchasing an older property as an investment it is common for buyers to proceed immediately with repairs to increase the potential for gaining a tenant. The ATO are focusing on these investments particularly where initial repairs are being claimed as expenses rather than having them added to the property cost base. If the property is not rented at the time of incurring initial repairs these amounts are not claimable as expenses. You cannot claim a deduction where income is not being produced by the asset however these may be claimable under capital works or as depreciating assets depending on their nature and use.
Repairs vs Improvements
Investment property owners are all too familiar with the need to repair and improve properties. It is important to understand the difference between repairing and improving a property as the tax consequences can vary dramatically. The ATO has released guidelines on what constitutes an “improvement” expense including:
• Whether or not the item replaced or renewed was a major and important part of the structure of the property
• Whether the work performed did more than meet the need for restoration of “efficiency of function”, bearing in mind that “repair” involves a restoration of a thing to a condition it formerly had without changing its character
• Whether the item was replaced with a new and better one, and
• Whether the new item has considerable advantages over the old one, including the advantage that it reduces the likelihood of repair bills in the future.
If you answer yes to any of the above it is likely you have an improvement rather than a repair and the expense is not deductible. However, depending on the item it may be depreciated at an accelerated rate or deductible over 40 years as a capital works.
Jointly owned Properties
Where a husband and wife own a property jointly it is important to have the correct split of income and expenses between each person. For example, if a property is owned 50/50 and the income and expenses are split 90/10 the ATO consider this a deliberate tax avoidance strategies and usually charge heavy penalties.
Refinancing
Investment property refinancing is very common; the reason why you are doing it is even more important than you may realise. If you refinance a property to pay for a holiday or even maybe your child’s school fees, and use the additional lending amount to do so, you can only claim the interest as it applies to the original loan and not the excess borrowing for your trip to, let’s say, Hawaii. While a great idea in theory the consequences once the ATO find the error can be extremely costly.
Rebuilding
If your rental property burns to the ground and you need to rebuild it you will need to consider how the expenses are deducted. The ATO has seen instances in the past where the entire cost of rebuilding the property was claimed in that year. While you can claim the costs associated with rebuilding a rental property it needs to be claimed over 40 years with a 2.5% of construction costs per year claimed as a capital works deduction.