4 tax return mistakes to avoid as a property investor

Property investment is a smart move to maximise your income and increase your financial freedom. However, renting out a property isn’t always easy, especially when it comes to tax.

Luckily property investors benefit from a number of tax deductions, but it’s still possible to make mistakes along the way. Here we’ll explain some of the common mistakes and misunderstandings investors have about filing their tax returns. To avoid making tax mistakes, it’s worth consulting with a property tax accountant and seeking up to date advice from the Australian Tax Office.

Mistake 1: Not knowing the difference between a repair and an improvement

As the owner of a rental property, you’ll inevitably have to deal with damage. Thankfully, the cost of repairs to damaged property is usually an immediate tax deduction - provided you meet the criteria for a repair. The goal of a repair is to restore the damaged feature back to its original working condition, rather than enhance the feature or object.

For example, if you repair a cracked tile, you would need to use the same kind of materials that were used on the original tiled surface. This would likely mean using the same kind of tile to replace the damaged one. However, if you replaced the damaged tiled surface with new, higher quality premium tiles, this would be considered an improvement.

An improvement is a change made to the investment property that can increase its value or desirability, rather than simply fixing a damaged object. For example, doing a kitchen renovation or installing air conditioning units would be considered improvements. Improvements are not immediate tax write-offs, but you may be able to claim for depreciation from the wear and tear of various features in the property in the future.

For major renovations, you can claim capital works deductions over the years. Typically you can claim a yearly capital works deduction of 2.5% for construction costs for 40 years post-construction.

Read more about investment property repairs and tax deductions here.

Mistake 2: Not understanding capital gains tax

Capital gains tax (CGT) is a tax you pay on any profit made from selling an investment property. Profit or loss (i.e. capital gain vs capital loss) is the difference between how much you originally paid for the property and how much you receive for selling it.

CGT is not a separate tax, and your gain or loss instead needs to be recorded in your income tax return as a part of your assessable income. The CGT rate will usually align with your income tax rate for that year.

If you enter a contract to sell in June 2021 and settle in July 2021, your capital gain or loss must be reported in your 2020-2021 tax return. It is based on when you enter the contract to sell, rather than when settlement occurs. While there are some exemptions, CGT is usually required to be paid after the sale on all investment properties. On the other hand, the sale of an owner occupied property won’t attract CGT.

The main reason you wouldn’t have to pay CGT is if you make a capital loss. One advantage here is that this loss can be used to offset future capital gains, but not any other type of tax.

Mistake 3: Not making sure the property is genuinely available for rent

While earning a rental income is a big drawcard for most property investors, some invest purely for the tax benefits. It may sound obvious, but in order to get these tax benefits, your investment property must be genuinely available for rent or already rented out. There is a difference between a property that isn’t available to rent and a property that is vacant but still available to rent.

The Australian Tax Office may investigate to ensure that the property was actually rented out during the financial year or that adequate effort was put into marketing the property to potential tenants. You will need to show that:

• You have an obvious intention to rent out the property
• You are advertising the property somewhere that a potential tenant is likely to find it
• Asking rent is reasonable and in line with similar properties in the area
• You do not have unreasonable rental conditions.

Read our investor's handbook for more information on what you should know before becoming a landlord.

Mistake 4: Claiming interest on a loan not exclusively used for the rental property

A benefit of being a property investor is that if you get a home loan to pay for the investment property, the interest on this loan is tax deductible. However, if you use funds from the loan (e.g. from a redraw facility) for expenses unrelated to the rental property, you can’t claim interest on this portion of the loan. This means that if you withdraw funds from your redraw facility to purchase a motorbike, for example, you won’t be able to claim interest on this part of the loan.

Filing a tax return as a property investor can be complicated. Consider speaking to a registered tax agent who specialises in property tax for specific guidance and to help maximise your tax benefits. Alternatively, the Australian Tax Office may be able to assist you.

• Related: How do taxes work on a rental investment property?
• Related: What expenses can I claim on an investment property?
• Related: How to make sure your rental property is never vacant

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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.