Owning a rental property can create valuable tax deductions, but only where expenses are properly connected to earning rental income and are claimed in the right way. The challenge for many landlords is not simply identifying an expense, but deciding whether it is immediately deductible, needs to be claimed gradually, must be apportioned, or cannot be claimed at all.
A well-organised approach can help you lodge a more accurate return, avoid overlooking legitimate deductions and preserve the records you may need when the property is eventually sold.
Start with the connection to rental income
The general starting point is that an expense must be incurred in earning rental income. Private, domestic and capital expenses are not ordinarily immediately deductible, even if they relate to a property that is now, or may later become, a rental.
For most landlords, this means deductions are generally available for the period when the property is:
– rented to tenants; or
– genuinely available for rent.
“Genuinely available” is important. A property that is advertised but only on unrealistic terms, at an uncommercial rent, or with significant restrictions that effectively prevent tenants from renting it may not meet the test. Likewise, deductions may need to be reduced where you reserve a holiday property for your own use, allow family or friends to stay without normal commercial arrangements, or occupy part of the property yourself.
Where an expense has both rental and private elements, it needs to be apportioned on a fair and reasonable basis. For example, if you rent out a room in your home, costs such as interest, council rates, insurance and utilities may need to be divided according to both the area used by the tenant and the time the space was rented or available.
The same principle applies if an investment property is rented for only part of the income year. Keep clear records showing when tenants occupied the property, when it was advertised, any periods it was unavailable due to repairs, and any private use.
Everyday holding and management costs you may be able to claim
Many of the ordinary costs of owning and managing a rental property may be deductible in the income year they are incurred, provided they relate to the rental activity and have not been paid or reimbursed by someone else.
Common examples include:
– advertising for tenants;
– property management fees and leasing commissions;
– bank fees relating to the rental property;
– council rates and water charges paid by the owner;
– land tax, where applicable;
– strata levies and body corporate charges;
– building, contents, landlord and public liability insurance;
– cleaning, gardening and lawn mowing;
– pest control;
– security monitoring or patrol costs;
– bookkeeping and accounting fees connected with the rental activity;
– legal expenses associated with managing an existing tenancy or collecting rent;
– telephone, postage and stationery costs directly connected with the property;
– servicing costs for existing items, such as a hot-water system; and
– costs of preparing tax affairs, including appropriate professional advice.
The key distinction is between costs incurred in operating the rental property and costs incurred to acquire, improve or sell it. Day-to-day management costs are more likely to be deductible now. Costs connected with buying, selling or substantially improving the property are more likely to be capital in nature.
Strata owners should also look beyond their individual levy notices. Depending on the nature of the expenditure, body corporate payments may relate to ongoing administration, repairs, depreciating assets or capital works in common areas. The treatment should follow the underlying nature of the expense rather than simply the label used on the levy notice.
Interest and borrowing expenses need careful treatment
Interest is often one of the largest rental property deductions, but it is also an area where errors are common.
Interest may be deductible where borrowed funds are used for an income-producing rental property. The focus is on how the borrowed money is used, not merely on which property is used as security for the loan.
For example, a loan secured against a rental property does not automatically make all interest deductible. If part of the borrowed funds is used to renovate the rental property and part is used for a private holiday, the interest must be apportioned. The private portion cannot be claimed simply because the loan is labelled an “investment loan”.
Common borrowing costs may include:
– loan establishment fees;
– lender’s mortgage insurance;
– title search fees;
– valuation fees required by the lender;
– mortgage registration costs;
– broker fees; and
– certain legal costs directly connected with obtaining finance.
Borrowing expenses are generally claimed over time rather than all at once. The exact treatment can depend on the amount, loan term and how the borrowed funds are used. If a loan is refinanced, extended, discharged early or partly redirected to private use, the deduction calculation may change.
Landlords should be especially careful with redraw facilities and offset accounts. A redraw can change the purpose of part of the borrowing if funds are withdrawn for private expenditure. An offset account is different because it generally operates by reducing the interest charged without changing the original use of the loan funds. The practical outcome can be very different, so it is worth seeking advice before restructuring loans or using available equity.
Also remember that loan principal repayments are not deductible. Interest may be deductible, but paying down the amount borrowed is a capital repayment.
Repairs, maintenance and improvements are not the same thing
The line between a deductible repair and a capital improvement is one of the most important distinctions for rental property owners.
Repairs and maintenance generally involve restoring something that is worn, damaged or deteriorating, or keeping the property in a tenantable condition. Examples might include fixing a leaking tap, replacing a broken window pane, repairing damaged plaster, servicing an appliance or repainting areas affected by ordinary wear and tear.
However, a cost is less likely to be immediately deductible where it involves:
– replacing an entire structure or substantial unit of property;
– upgrading the property beyond its former state;
– renovating a kitchen or bathroom;
– adding a new room, deck, garage or pergola;
– replacing an entire fence or roof;
– landscaping or major structural work; or
– remedying defects, damage or deterioration that existed when you acquired the property.
Those costs may still have tax value, but they may need to be claimed gradually as capital works deductions, as a deduction for the decline in value of a depreciating asset, or included in the property’s cost base for capital gains tax purposes.
Initial repairs deserve particular attention. If you purchase a property with known damage or deterioration and repair it before, or shortly after, making it available for rent, the work may be treated as capital rather than an immediate repair deduction. This can apply even if the expenditure feels necessary to make the home habitable.
A practical example
Suppose a landlord buys an older unit and replaces a cracked bathroom tile, fixes a leaking tap and services the existing air conditioner after a tenant moves out. These costs may be repairs or maintenance if they restore existing items.
If the landlord instead removes the entire bathroom and installs a new, upgraded bathroom with a different layout and modern fixtures, the project is more likely to be capital in nature. The work may still be relevant for tax purposes, but it should not automatically be claimed as an immediate repair deduction.
Before work begins, keep the builder’s quote, invoices, photographs and a brief description of why the work was required. These records make it much easier to support the correct tax treatment later.
Do not overlook depreciation and capital works deductions
Not every allowable rental property deduction is claimed immediately. Some costs are recognised over time.
A depreciating asset is generally an item with a limited effective life that can reasonably be expected to decline in value. In a rental property, this can include separately identifiable items such as appliances, carpets, curtains, blinds, hot-water systems, air-conditioning equipment and certain removable fittings.
A deduction may be available for the decline in value of eligible depreciating assets while they are used to produce rental income. The method used, the effective life of the asset, its cost and the period it was installed and ready for use can all affect the claim.
There are important restrictions for second-hand depreciating assets in residential rental properties. Individual landlords and many trusts cannot simply claim depreciation on every used appliance or fixture that came with an established property. Different outcomes can apply where the asset is new, where the property activity amounts to a business of letting properties, or where the owner is an entity that falls within an exception.
For this reason, a depreciation schedule should not be treated as a generic checklist exercise. It needs to reflect the particular property, ownership structure and assets actually acquired or installed.
Capital works deductions are different. They generally relate to construction expenditure on buildings and structural improvements, rather than removable plant and equipment. Depending on the facts, this may include expenditure on:
– the original building;
– extensions and alterations;
– structural renovations;
– retaining walls;
– driveways;
– fences;
– patios and pergolas; and
– other qualifying structural improvements.
Capital works deductions are generally spread over a long period and are only available once construction is complete. The availability and calculation of a deduction can depend on when the relevant construction began, the type of work undertaken and how the area is used.
A qualified quantity surveyor may be able to estimate eligible construction expenditure where original construction records are unavailable. Their fee for preparing an appropriate estimate may itself be deductible as a cost of managing your tax affairs.
It is also important to consider the future capital gains tax position. Capital works deductions claimed, or that could have been claimed, can affect the property’s cost base when it is sold. Keeping a complete depreciation schedule and a record of capital improvements is therefore just as important for a future sale as it is for this year’s tax return.
Avoid common traps with travel, ownership, GST and records
Some of the most expensive rental-property mistakes happen when landlords rely on assumptions rather than the specific tax rules.
Travel expenses relating to a residential rental property are generally not deductible for individual landlords unless an exception applies. This can include travel to inspect the property, arrange repairs, collect rent or meet a property manager. The rules differ where the property is used in carrying on a business of letting rental properties or the owner is an eligible excluded entity.
Ownership is another area where informal arrangements can cause confusion. Where co-owners are not carrying on a rental property business, rental income and deductions are generally divided according to their legal interest in the property. A couple cannot usually decide that the higher-income owner will claim a larger share of the loss merely because they paid more of the bills.
Residential rent is generally treated as input taxed for GST purposes. This usually means landlords do not charge GST on ordinary residential rent, but they also cannot claim GST credits for costs that relate to making that input-taxed supply. Commercial premises and short-stay accommodation arrangements can have different GST outcomes, so do not assume residential rules apply to every type of property income.
Good records are the foundation of a sustainable claim. Keep documents that show what you spent, when you incurred the expense, what it related to and how you calculated any apportionment. Useful records include:
– purchase and settlement documents;
– loan statements and finance contracts;
– property management statements;
– tenant leases and rental advertisements;
– invoices and receipts;
– bank and credit card statements;
– insurance policies;
– strata levy notices;
– photographs and reports supporting repairs;
– depreciation schedules;
– records of private use; and
– documents for capital improvements and disposal costs.
Keep rental records for the required retention period after lodging your tax return. Records relevant to a future capital gain or loss may need to be retained for much longer, including until after the property is sold and the relevant tax position is finalised.
Make each claim work harder through good classification
The best way to maximise legitimate rental property deductions is not to chase every possible expense. It is to classify each cost correctly, claim it in the appropriate period and retain evidence that supports the connection with rental income.
Focus on the fundamentals: separate private and rental spending, keep loan purposes clear, distinguish repairs from improvements, review depreciation opportunities and maintain records that will also help when you eventually sell.
This article is general information only and is not personal financial or tax advice. Rental property deductions can vary significantly depending on the property, ownership structure, finance arrangements and use of the property. Speak with a registered tax agent or accountant, such as, for advice tailored to your circumstances.