How do taxes work on a rental investment property?

As a property investor, you can expect your tax obligations to be different to someone who just owns the property they live in. Luckily, most of these tax changes are favourable and you will be entitled to a number of tax deductions.

It’s essential to be aware of your tax commitments during your ownership and once you sell your property. Keep reading to find out what you need to know about tax deductions, negative gearing and capital gains tax.

How is my rental income taxed?

The Australian Taxation Office (ATO) stipulates that any rental income you receive forms part of your assessable taxable income. Rental income is typically taxed at the same rate as your marginal tax rate for that year.

However, if your property is negatively geared, you will be able to claim these shortfalls as tax deductions. We’ll cover what negative and positive gearing is in the next section.

What is the difference between positive and negative gearing?

It’s important to understand the difference between positive and negative gearing as how your rental property is structured will impact your income and tax payable.

What is positive gearing?

Positive gearing refers to when your rental income exceeds any home loan repayments and property expenses incurred for the investment property. The equates to a positive cash flow and allows investors to generate a passive income.

There are many benefits to an increased income through positive gearing. It can allow you to:

• Work less or retire sooner
• Have the funds to funnel into other investments
• Pay off your home loan and other loans faster
• Have more money to spend on holidays and your lifestyle
• Increase your savings

At the same time however, you will owe more tax as your taxable income increases.

What is negative gearing?

Negative gearing is the opposite of positive gearing. When your home loan repayments and property expenses outweigh your rental income, this means your investment property is negatively geared.

Luckily, any losses you incur will be tax deductible. Because of this, investors will choose negative gearing as a strategy to maximise their tax deductions. They usually select properties in high growth areas where the property’s rapidly increasing value will help offset these short term losses once the property is sold.

This is a high risk strategy and you must be able to handle the reduced cash flow and lack of immediate gratification. It may be worth speaking to a financial advisor if you’re interested in negatively gearing your rental property.

What is capital gains tax?

When you make a profit from selling an asset it’s called a capital gain, you will likely be required to pay capital gains tax (CGT). For example, if you sell your investment property and make a $100,000 profit, you may have to pay CGT on that amount.

The CGT rate usually aligns with your marginal/income tax rate and is reported as part of your assessable income. If you entered a contract to sell your property in June 2020, but didn’t settle until July, you are still required to report your capital gain or loss in the 2019-2020 tax return.

CGT only applies to investment properties, not owner occupied properties. This means that if you sell your primary place of residence and make a profit, you won’t be taxed on this profit. If you avoid selling your investment property in the first year of ownership, you’ll be entitled to a 50% discount on CGT.

If you make a capital loss, you aren’t required to pay CGT. You can use this loss to offset any capital gain in the future, but not for any other kind of tax.

• Related: Want to invest while renting? Read our guide to Rentvesting.

What tax deductions CAN you claim on an investment property?

Property investors are eligible to claim tax deductions on a range of rental property-related expenses. Make sure that you check your eligibility before making claims, but here are some examples:

1. Interest on your investment home loan

Property investors can claim all interest paid on their mortgage as tax deductible. This is a significant tax saving that also includes any loan fees, such as:

• Annual/monthly loan maintenance fees
• Offset account fees
• Withdrawal fees for redraw facilities

While you can claim on interest, it’s still smart to seek out a competitive interest rate. If you have an interest only home loan, you’ll be able to claim all of your interest only payments.

• Related: Are you ready to pay more when your interest-only period ends?

2. Repairs and maintenance

You’ll inevitably be required to make repairs on damaged property features during your years of ownership. Luckily, repairs are usually a tax deduction.

To be considered a repair, any damage must be fixed by restoring the item or feature to its original condition. This means that you can’t sneakily enhance the damaged item and claim it as a repair. For example, if you replace the panels of a damaged fence with steel, when they were originally timber, this is considered an improvement.

Improvements are still eligible for tax benefits, but you won’t be able to claim them as an immediate deduction. Instead, you can claim depreciation over the years.

Maintenance is also an immediate tax deduction. It refers to routine work done to preserve the liveable condition of a property, such as plumbing and lawn-mowing. A lot of maintenance work can help prevent damage and therefore prevent further expenses down the track.

3. Depreciation of building structure and assets

Investors can claim the depreciation of the rental property building structure and various features. Depreciation is not an immediate tax deduction, and instead requires a Quantity Surveyor to devise a depreciation schedule that summarises the deductions available over the life of your property.

Any improvements you make are claimed under the capital works or capital allowances classifications. An improvement is generally a change you make to the property that increases its value or desirability. Examples of improvements can include:

• New appliances
• Kitchen and bathroom renovations
• Property extensions
• Upgrading fencing
• Re-doing landscaping

You can even claim the depreciation of improvements made by the previous owners.

4. Advertising for tenants

You may have to fork out some cash to commence your search for tenants. This could include paying for an agent, photography or an online listing. All of this is tax deductible.

5. Strata fees, council rates and some bills

If your property is on a strata title (common with apartments), your body corporate fees will count as a deduction. Similarly, council rates, water, energy, gas and electricity bills can be claimed.

6. Other deductions

Other common tax deductions include:

• Property management and agency fees
• Some legal fees
• Stationary
• Travel costs
• Land tax
• Pest control

Can you still claim tax deductions while you aren’t renting out your investment property?

When an investment property is empty by choice, you aren’t able to claim the usual rental property tax deductions. However, it’s still smart to keep track of your expenses as they may be able to offset capital gains tax when you sell in the future.

You can still make tax claims if your property is currently empty but you are actively trying to find tenants. The ATO may require evidence that you have been looking for tenants, such as online rental listings and proof of communication with a real estate agency.

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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.