Rent income and deductions

 Commissioner’s statement on rental deductions 

 

Rental property expenses

What you can claim

You can claim a deduction for certain expenses you incur for the period your property is rented or is available for rent. However, you cannot claim expenses of a capital or private nature – although you may be able to claim decline in value deductions or capital works deductions for certain capital expenditure or include certain capital costs in the cost base of the property for capital gains tax purposes.

Types of rental expenses

There are three categories of rental expenses:

Apportioning expenses

There may be situations where not all of your expenses are deductible and you need to work out the deductible portion. To do this you subtract any non-deductible expenses from the total amount you have for each category of expense; what remains is your deductible expense. The following sections give examples of when you may need to apportion your expenses.

Part-year rental

If you use your property for both private and income-producing purposes, you cannot claim a deduction for the portion of any expenditure that relates to your private use. Examples of properties you may use for both private and income-producing purposes are holiday homes and time share units. In these cases you can claim expenses only for the period your property was rented or available for rent.

In some circumstances it may be easy to decide when expenditure is private in nature. For example, council rates paid for a full year would need to be apportioned on a time basis according to rental and private use where a property is used for both purposes during the year.

In other circumstances, where you are not able to specifically identify the direct cost, your expenses will need to be apportioned on a reasonable basis.

Example

Pete has a holiday home in the Hunter Valley. He spends about one month each year there on holiday. For the remainder of the year, it is advertised through a real estate agent. He can claim only those expenses relating to the period it is either rented or available for rent.

Part-property rental

If only part of your property is used to earn rent, you can claim only that part of the expenses that relates to the rental income. You will need to work out a reasonable basis to apportion the claim. As a general guide, apportionment should be made on a floor area basis. For example, work out the floor area in the part of the property that your tenant rents. Then add a reasonable figure for tenant access to the general living areas, including garage and outdoor areas. Take this total and work out what proportion it is of the whole floor area of your property. This will give you a reasonable basis to apportion expenses. Taxation Ruling IT 2167—Rental properties will give you more details on this point.

Renting out your property at non-commercial rates

If you rent out your property, or part of your property, at less than normal commercial rates, this may limit the amount of deductions you can claim.

Example

Karen allowed her friend Geraldine to move into her rental property for 6 weeks. Geraldine paid reduced rent of $100 per week, although the commercial rate of rent for the property is $200 per week.

Karen incurred rental property expenses of $900 for the 6 week period.

As the property was rented for personal reasons at less than commercial rates and Karen's expenses exceeded the rent she received, her deductions are limited to $600 (that is $100 x 6 weeks) for the period. In her circumstance, she can only claim deductions up to the amount of rent she received.

Pre-payment of expenses

If you prepay a rental property expense, such as insurance or interest on money borrowed, that covers a period of 12 months or less and the period ends on or before 30 June 2005, you can claim an immediate deduction. A prepayment that doesn’t meet these criteria and is $1,000 or more may have to be spread over two or more years. This is also the case if you carry on your rental activity as a business and have not elected to be taxed under the simplified tax system for small businesses – see Deductions for prepaid expenses.

What you can’t claim

Expenses you are not able to claim include:

Examples of expenses of this kind include the purchase cost of the property, conveyancing costs, advertising expenses and stamp duty on the transfer of the property, but not stamp duty on a lease of property. However, if you acquired the property after 19 September 1985, these costs may form part of the cost base of the property for capital gains tax purposes.

Expenses you can claim immediately

You may be able to claim an immediate deduction in the year you incur the expense for the following rental expenses:

You can claim a deduction for these expenses only if you actually incur them.

Body corporate fees and charges

You may be able to claim a deduction for body corporate fees and charges you incur for your rental property.

Body corporate fees and charges may be incurred to cover the cost of day-to-day administration and maintenance or they may be applied to a special purpose fund.

Payments you make to body corporate administration funds and general purpose sinking funds are considered to be payments for the provision of services by the body corporate and you can claim a deduction for these levies at the time you incur them. However, if the body corporate requires you to make payments to a special purpose fund to pay for particular capital expenditure, these levies are not deductible. Similarly, if the body corporate levies a special contribution for major capital expenses to be paid out of the general purpose sinking fund, you will not be entitled to a deduction for this special contribution amount. This is because payments to cover the cost of capital improvements or capital repairs are not deductible — see Taxation Ruling TR 97/23-Income tax: deductions for repairs. You may be able to claim a capital works deduction for the cost of capital improvements or capital repairs once the cost has been charged to either the special purpose fund or, if a special contribution has been levied, the general purpose sinking fund.

A general purpose sinking fund is one established to cover a variety of unspecified expenses (some of which may be capital expenses) that are likely to be incurred by the body corporate in maintaining the common property (for example, painting of the common property, repairing or replacing fixtures and fittings of the common property). A special purpose fund is one that is established to cover a specified capital improvement to the common property which is likely to be a significant expense that cannot be covered by ongoing contributions to a general purpose sinking fund.

If the body corporate fees and charges you incur are for things like the maintenance of gardens, deductible repairs and building insurance, you cannot also claim deductions for these as part of other expenses. For example, you cannot claim a separate deduction for garden maintenance if that expense is already included in body corporate fees and charges.

Interest on loans

If you take out a loan to purchase a rental property, you can claim the interest charged on that loan, or a portion of the interest, as a deduction. However, the property must be rented, or available for rental, in the income year for which you claim a deduction. If you start to use the property for private purposes, you cannot claim any interest expenses you incur after you start using the property for private purposes.

If you take out a loan to purchase land on which to build a rental property or to finance renovations to a property you intend to rent out, the interest on the loan will be deductible from the time you took the loan out. However, if your intention changes, for example you decide to use the property for private purposes and you no longer intend to use it to produce rent or other income, you cannot claim the interest after your intention changes.

While the property is rented, or available for rent, you may also claim interest charged on loans taken out:

Loans for private purposes

Banks and other lending institutions offer a range of financial products which can be used to acquire a rental property. Many of these products permit flexible repayment and redraw facilities. As a consequence, a loan might be obtained to purchase both a rental property and a private car. In cases of this type, the interest on the loan must be divided into deductible and non-deductible parts according to the amounts borrowed for the rental property and for private purposes.

Example

Fergus decides to use his bank’s ‘Mortgage breaker’ account to take out a loan of $209,000 from which $170,000 is to be used to buy a rental property and $39,000 is to be used to purchase a private car. The bank officer advises him that he will need to work out each year how much of his interest payments is tax deductible. The officer gives him the following whole year example based on a loan interest rate of 6.75% per annum, and assuming that the property is rented from 1 July.

Interest for year 1 = $209,000 x 6.75% = $14,108

Apportionment of interest payment related to rental property:

Total interest expense

X

rental property loan
total borrowings

=

deductible interest

$14,108

x

$170,000
$209,000

=

$11,475

If you have a loan account that has a fluctuating balance due to a variety of deposits and withdrawals and it is used for both private purposes and for rental property purposes, you must keep accurate records to enable you to calculate the interest that applies to the rental property portion of the loan; that is, you must separate the interest that relates to the rental property from any interest that relates to the private use of the funds.

Some rental property owners borrow money to buy a new home and then rent out their previous home. If there is an outstanding loan on the old home and the property is used to produce income, the interest outstanding on the loan, or part of the interest, will be deductible. However, an interest deduction cannot be claimed on the loan used to buy the new home because it is not used to produce income. This is so whether or not the loan for the new home is secured against the former home.

If you prepay interest it may not be deductible all at once – see Prepayment of expenses for more information.

For more information about the deductibility of interest, see the following taxation rulings and determinations:

Thin capitalisation

If you are an Australian resident and you (or any associate entities) have certain overseas interests, or you are a foreign resident, these rules may apply if your debt deductions, such as interest (combined with those of your associate entities) for 2003-04 are more than $250,000.

Under the thin capitalisation rules, you may only be able to claim a reduced amount of your debt deductions. For more information, read the Guide to thin capitalisation (NAT 4462).

Lease document expenses

The costs of preparing and registering a lease and the cost of stamp duty on a lease are deductible to the extent that you have used, or will use, the property to produce income. This includes any such costs associated with an assignment or surrender of a lease.

For example, freehold title cannot be obtained for properties in the Australian Capital Territory (ACT) as they are commonly acquired under a 99 year crown lease. Therefore, stamp duty, preparation and registration costs incurred on the lease of an ACT property are deductible to the extent that you use the property as a rental property.

Legal expenses

Some legal expenses incurred in producing your rental income are deductible – for instance, the cost of evicting a non-paying tenant.

Most legal expenses, however, are of a capital nature and are therefore not deductible. These include costs of:

Non-deductible legal expenses may, however, form part of the cost base of your property for capital gains tax purposes.

Example

In September 2003, Dave’s tenants moved out owing four weeks rent. Dave retained the bond money and took the tenants to court to terminate the lease and recover the balance of the rent. The legal expenses he incurred doing this are fully deductible. Dave was seeking to recover assessable rental income, and he wished to continue earning income from the property. Dave must include the retained bond money and the recovered rent in his assessable income in the year of receipt.

Mortgage discharge expenses

Mortgage discharge expenses are the costs involved in discharging a mortgage other than payments of principal and interest. These costs are deductible in the year they are incurred to the extent that you took out the mortgage as security for the repayment of money you borrowed to use to produce assessable income.

For example, if you used a property to produce rental income for half of the time you held it and used it as a holiday home for the other half of the time, 50% of the costs of discharging the mortgage are deductible.

Mortgage discharge expenses may also include penalty interest payments. Penalty interest payments are amounts paid to a lender, such as a bank, to agree to accept early repayment of a loan, including a loan on a rental property. The amounts are commonly calculated by reference to the number of months interest payments would have been made had the premature repayment not been made.

Penalty interest payments relating to a rental property are deductible if:

Repairs

Expenditure for repairs you make to a rental property may be deductible. However, the repairs must relate directly to wear and tear or other damage which occurred as a result of renting out the property.

Repairs generally involve a replacement or renewal of a worn out or broken part – for example, replacing some guttering damaged in a storm or part of a fence that was damaged by a falling tree branch.

However, the following expenses are capital, or of a capital nature, and are not deductible:

You may be able to claim capital works deductions for these expenses. Expenses of a capital nature may form part of the cost base of the property for capital gains tax purposes, but not generally to the extent that capital works deductions have been or can be claimed for them.

Example

Tom and Vicki needed to do some repairs to their newly acquired rental property before the first tenants moved in. They paid an interior decorator to re-paint dirty walls, replace broken light fittings and repair doors to two bedrooms. They also discovered white ants in some of the floor boards. This required white ant treatment and replacement of some of the boards.

These expenses were incurred to make the property suitable for rental and did not arise from Tom and Vicki’s use of the property to generate assessable rental income. The expenses are capital in nature and Tom and Vicki are not able to claim a deduction for these expenses.

Repairs to a rental property will generally be deductible if:

If you no longer rent the property, the cost of repairs may still be deductible provided:

Example

After the last tenants moved out in September 2003, Tom and Vicki discovered that the stove didn't work, kitchen tiles were cracked, and the toilet window was broken. They also discovered a hole in a bedroom wall that had been covered with a poster. In October 2003 Tom and Vicki paid for this damage to be repaired so they could sell the property.

As the tenants were no longer in the property, Tom and Vicki were not using the property to produce assessable income. However, they could still claim a deduction for repairs to the property because the repairs related to the period when their tenants were living in the property and the repairs were completed before the end of the income year in which the property ceased to be used to produce income.

Examples of deductible repairs

Examples of repairs for which you can claim deductions are:

Examples of improvements for which you cannot claim deductions are:

For more information see the publication Guide to capital gains tax and Taxation Ruling TR 97/23-Income tax: deductions for repairs.

Travel expenses

If you travel to inspect or maintain your property or collect the rent, you may be able to claim the costs of travelling as a deduction. You are allowed a full deduction where the sole purpose of the trip relates to the rental property. However, in other circumstances you may not be able to claim a deduction or you may be entitled to only a partial deduction.

if you fly to inspect your rental property, stay overnight, and return home the following day, all of the airfare and accommodation expenses would generally be allowed as a deduction.

Example

Although his local real estate agent managed his rental property, Sam decided to inspect the property three months after the tenants moved in. During the income year Sam also made a number of visits to the property to carry out minor repairs. He travelled a total of 160km during the course of these visits. On the basis of a 61 cents per km rate for his 2 litre car, Sam can claim the following deduction:

Distance travelled x rate per km = deductible amount

160 km x 61 cents per km = $97

On his way to tennis each week, Sam drove past the property to 'keep an eye on things'. He is not entitled to a deduction for these motor vehicle expenses as they are incidental to the private purpose of the journey.

Apportionment of travel expenses

Where travel related to your rental property is combined with a holiday or other private activities, you may need to apportion the expenses.

If you travel to inspect your rental property and combine this with a holiday, you need to take into account the reasons for your trip. If the main purpose of your trip is to have a holiday and the inspection of the property is incidental to that main purpose, you cannot claim a deduction for the cost of the travel. However, you may be able to claim local expenses directly related to the property inspection and a proportion of accommodation expenses.

Example

Dave and Tina own a rental property in a North Queensland resort town. They spent $1,000 on airfares and $1,500 on accommodation when they travelled from their home in Perth to the resort town, mainly for the purpose of holidaying, but also to inspect the property. They also spent $50 on taxi fares for the return trip from their hotel to the rental property. Dave and Tina spent one day on matters relating to their rental property and nine days swimming and sightseeing.

No deduction can be claimed for any part of the $1,000 airfares. They can claim a deduction for the $50 taxi fare.

A deduction for 10% of the accommodation expenses (10% of $1,500 — that is $150) would be considered reasonable in the circumstances. The total travel expenses Dave and Tina can claim are $200 ($50 taxi fare and $150 accommodation). Accordingly, Dave and Tina can each claim a deduction of $100.

Expenses deductible over a number of income years

There are three types of expenses you may incur for your rental property that may be claimed over a number of income years:

Borrowing expenses

Borrowing expenses are expenses directly incurred in taking out a loan for the rental property. They include:

If you take out an insurance policy that provides for your loan on the property to be paid out in the event that you die or become disabled or unemployed, the premiums are not borrowing expenses.

Interest expenses are not borrowing expenses.

The following table shows when deductions for borrowing expenses may be claimed.

If the total borrowing expenses are ...

Then the expenses are...

$100 or less

fully deductible in the first year.

more than $100

deductible over the term of the loan or five years (whichever is less)

If you repay the loan early and in less than five years, you can claim a deduction for the balance of the borrowing expenses in the year of repayment.

If you obtain the loan part way through the income year, the deduction for the first (and last) year will be apportioned according to the number of days in the year that you had the loan.

Example

Luke took out a loan of $209,000 to purchase a rental property (for $170,000) and a private motor vehicle (for $39,000). The period of the loan was 25 years. He incurred borrowing expenses on the loan of $1,670, which included:

As Luke's borrowing expenses are more than $100, he must apportion them over the lesser of:

As the loan was to be used for both income producing and non-income producing purposes, only the income producing portion of the borrowing expenses is deductible. As Luke obtained the loan on 17 July 2003, the borrowing expense deduction for the first year would be worked out using the following formula:

borrowing expenses

X

rental property loan
total borrowings

X

number of relevant days in year
number of days in 5 years

$1,670

X

$170,000
$209,000

X

350 days
1,827 days

= $260

Luke will be able to claim a deduction of $260 in his 2003-04 tax return.

Capital works deductions

You can deduct certain kinds of construction expenditure. In the case of residential rental properties, the deductions would generally be spread over a period of 25 or 40 years. These are referred to as capital works deductions. Your total capital works deductions cannot exceed the construction expenditure. No deduction is available until the construction is complete.

Deductions based on construction expenditure apply to capital works such as:

Deductions can be claimed only for the period during the year that the property is rented or is available for rent.

If you can claim capital works deductions, the construction expenditure on which those deductions are based cannot be taken into account in working out any other types of deductions to be claimed, such as deductions for decline in value of depreciating assets.

The amount of the deduction you can claim depends on the type of construction and the date the construction started. Rental properties will help you determine if you qualify for a capital works deduction.

Decline in value of depreciating assets

Under the uniform capital allowance (UCA) system, you can deduct an amount in relation to a depreciating asset that you held for any period during an income year, equal to its decline in value over that period. However, your deduction is reduced to the extent you use the asset – or have it installed ready for use – for purposes other than that of producing assessable income, for example, a private purpose.

You work out your deduction for the decline in value of a depreciating asset using either the prime cost or diminishing value method. Both methods are based on the effective life of the asset.

The publications Guide to depreciating assets and Rental properties will assist you in understanding the rules for working out your deduction for decline in value.

Capital gains tax

If you acquired your rental property or depreciating assets used in relation to your rental property after 19 September 1985, capital gains tax may apply when you dispose of the property and/or the depreciating assets.

For more information about the capital gains tax implications of disposing of a rental property, read Rental properties and Guide to capital gains tax.

What to read/do next

For general information about rental income, read Income from rent.

For more detailed information, read the following publications:

The following rulings provide guidance on particular situations:

If you need assistance applying this information to your own situation, call the Personal Tax Infoline on 13 28 61.

Last Modified: Friday, September 24, 2004

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