- by Chan & Naylor
In this podcast, Ed Chan and Janelle Bartlett talk about common tax return mistakes property owners make. Check out what you can do to avoid them and helpful tax tips you can start doing today!
Watch the video, listen to the audio recording, or just read the transcript below:
Ed Chan: Hello everyone. My name is Ed Chan, I’m the non-executive chairman and co-founder of the Chan and Naylor Group. I have with me today, Janelle Bartlett, our managing partner of our Brisbane and Capalaba offices in the state of Queensland. Welcome, Janelle.
Janelle Bartlett: Hi Ed, how are you?
Ed Chan: I’m well, thank you. We’ve got a bit of good information to share with everyone.
Janelle Bartlett: Yes, that’s right.
Common Tax Return Mistakes
Ed Chan: The topic today is just around the common tax mistakes that people make when they’re preparing the tax returns and claiming expenses. I believe that this sort of started in realestate.com. There was an article that went in there and then the Courier Mail took that up as well. Is that right?
Janelle Bartlett: That’s right. That was pretty exciting, actually. Your Investment Property magazine approached Chan and Naylor for some information at tax time. And you guys asked me to write an article about common mistakes that people make.
I wrote the article and Your investment Property magazine quite liked it, so they put that in a nice prime spot in their magazine, and then the Courier Mail and realestate.com picked that up and republished it. So, there’s been a fair bit of interest, which is very good. Yeah.
Ed Chan: Oh wow. That’s fantastic. So why don’t I cover up on some of those common mistakes for our listeners. And that might be interesting listening to them because there are quite a few things that you got to be careful of. Some of these things are not very obvious, so let’s just talk about them.
I guess the very first one is, when you first buy a property, there’s often this initial repairs that you’ve got to incur. There is a different way of treating those. Janelle, could you explain, please?
Mistake 1: Claim Initial Repairs On a Purchased Property
Janelle Bartlett: Yeah, that’s right. And it’s a common mistake that people make. If you buy a property and it needs, for example, the inside painting and you paint the inside of it, a lot of people think that’s a repair, great, I’ve got a tax deduction.
But if the property required the repair when you purchased it, it’s considered an initial repair and it’s not deductible. It forms part of the cost base. So the ATO view is, that that’s part of the capital of acquiring the property.
Janelle Bartlett: We use a six month rule of thumb and it’s really, that’s not in the legislation, it’s just a rule of thumb that we use.
So, if you incur repairs before- in the first six months, it’s really unlikely that they are actually repairing something in the building. It’s more likely that it’s repairing a condition that you acquired when you acquired the property.
Janelle Bartlett: Now there are some exceptions to that. For example, a burst water main, you know, after the tenants moved in. Obviously that repair is going to be allowable.
But those things that bring the property up to the standard that you want, are all part of the cost base. They’re all capital and not claimable in that first year.
Ed Chan: So what the ATO is saying is that, you’ve bought the property at a cheaper price than you would have if the repairs had been incurred.
So effectively, if you then spend 20 or 30 grand to fix something up the property there, you must have bought it for 20 or 30 grand less than what it was actually, should have been sold for. So they will then say that’s just part of your purchase price of the property.
Janelle Bartlett: Exactly right. Yeah, that’s right.
Ed Chan: But then, when you come to sell the property, later on, then the capital gains tax is less because your cost base is increased by these initial repairs.
Janelle Bartlett: That’s right. Some clients are very disappointed that they can’t claim that repair, but they don’t lose it altogether. If it becomes part of the cost base and a that’s used as a cost against their profit when they do eventually sell.
Ed Chan: Yes. The capital profit when they sell.
Janelle Bartlett: That exactly right.
Ed Chan: Which is different to an income profit because the income profit doesn’t get a 50% exemption. Whereas the capital profit gets a 50% exemption.
Janelle Bartlett: That’s right. Exactly right.
Ed Chan: You need to hold the- to get the 50% you need to have held the asset for more than 12 months.
Janelle Bartlett: That’s right. Yes, that’s right. That’s from contract to contract. It’s not from settlement to settlement. It’s contract to contract. So…
Ed Chan: But the date on the contract is the date that you go by.
Janelle Bartlett: That’s right. Someone selling a property will often try and make the settlement up over the next financial year, but have signed a contract on- June for example with the settlement in July.
They’re often very disappointed to realize that that capital gain comes into the first year or into the year- the June is related to. so that’s something to be careful of too when you’re selling.
Ed Chan: Yes. Okay. And the other common tax mistake that people make is to do with capital items? Can you explain that please, Janelle?
Mistake 2: Claim Appliances and Purchases $300 and Over
Janelle Bartlett: Basically capital items, we’re talking about large items like a dishwasher or, a hot water system’s a good one. And if it’s over $300 it has to be depreciated. If it’s under $300 or $300- If it’s $300 or over it has to be depreciated, under $300 you can claim it one off.
But you’ve also got to be careful, you have to be the first owner. So if you’ve held a property prior to the 9th of May, 2017 and you purchased a property and it had items in it, like hot water systems, curtains, carpets, those things are on a depreciation schedule that you can claim.
Janelle Bartlett: But if you’ve purchased a property with existing items in it after that date, you can only claim them if you’re the first owner. So if you’ve bought a brand new house as a rental property, it’s likely that you’ll be able to claim them.
But if you bought a property just off the normal market, where someone else’s had that property previously, you’re not going to be able to claim those items. Again they’ll form part of the cost base.
Ed Chan: Yes. And that change came about in May 2017?
Janelle Bartlett: That’s correct, yeah. Budget night. Yes.
Ed Chan: Yes. And prior to that it was a different treatment to that?
Janelle Bartlett: That’s right. And anyone that held properties prior to that can continue with the old rules.
Ed Chan: Okay, that’s good to know. All right. The other, sort of common mistake, common tax mistake that people make is around borrowing costs.
So when you come to buy a property, there’s the costs of getting financed and there are various different items in getting that finance and perhaps you could share some of those different items and explain how they’re supposed to be treated.
Mistake 3: Write Off Borrowing Costs Over $100 In the First Year
Janelle Bartlett: Yes. Well, basically if they’re over $100 they need to be written off over five years. Under $100 can be written off in the first year. And the sort of items are application fees for your loan, sometimes your mortgage insurance, those sorts of things.
Janelle Bartlett: Basically, if you look at that first bank statement after you settle, you see all those little line items, of things that the bank has deducted, that is on your offer letter.
It’s a matter of looking at those and seeing the items that are under $100 you can claim, but anything over $100 we need to put on a schedule and just depreciate that down or claim it over five years.
Ed Chan: Okay. And that schedule then, as part of the tax return, and every year you’ll just take a portion of that and claim it in the tax return until it’s fully claimed over five years.
Ed Chan: Okay. All right. Okay, that’s good. Thank you, Janelle. Now, the other one is, that causes a lot of confusion is- are the costs to do with settlement costs and there are things like, you know, legal costs, and stamp duty and so forth and often clients ask to see if they can claim that as a tax deduction.
Could you explain how the treatment of that, is, occurs.
Mistake 4: Claim All Settlement Costs
Janelle Bartlett: Yes. Again, those things form part of the cost base. So they’re useful when you sell the property and we’re working out your capital gain.
It will increase your cost base and reduce your capital gain, but it can’t be claimed against your rental schedule in the first year that you rent out the property.
Janelle Bartlett: It is things like legal fees, stamp duty. However, on the settlement letter, there’s adjustments of rates and water and things like that.
Body corporate, if it’s a body corporate. Those adjustments do need to be reflected in your return. So, it might be that there’s some additional rates to claim or it might actually be in a reduction in the rates. And it depends on the time that the rates have been paid to.
Janelle Bartlett: So, for example, the seller has paid rates up to 10 days after you purchased, basically your going to pay them back for those 10 days and we need to pick that up in your tax return so that you get that benefit.
So there’s all those sorts of settlement adjustments as well, which are pretty important to look at.
Ed Chan: Okay. And I guess the other really confusing part is that what is settlement costs and what is deductible when some of that appears on your settlement sheet provided by the solicitor.
If you can think of it like if it’s to do with the property, it’s part of the cost of the property and that’s a capital item so you can’t claim that as a deduction, but you can add it to the cost base of the property.
And on the other side if it’s to do, if it’s a revenue expense to do with the running costs or the rental, like water rates and council rates and so forth, that’s part of the revenue side of things and then that’s claimable.
So just to help clear the confusion, because it is very confusing because often those two items are in the settlement sheet from the lawyer.
Ed Chan: Then another one, a really big one. This is a big, big one, that a lot of people make a mistake in when it was time to do their tax returns.
It’s around their mortgage payments. You know their payments that I’ve got to make back to the bank. And often, sometimes a loan can be an interest-only loan and other times it can be interest and principal.
But they give you one amount per month and they say that you’re paying this amount per month, and often you don’t know how much principal was in there or how much interest in there and often people claim the whole lot.
Now, what is the correct way of doing it?
Mistake 5: Claim Principal Amount Repayments
Janelle Bartlett: Well obviously the interest is claimable, not the principal part of the loan. So, it is a common mistake people say I’m paying this, I’m paying this to have this rental property, it forms part of your cashflow analysis, working out, you know, what can you afford the property, that type of thing at the beginning.
But it isn’t all tax deductible. Only the interest component is tax deductible. So if you have an interest only loan, yes your payment is deductible. But most of the loans are PNI, or principal and interest, and only the interest portion is deductible.
Janelle Bartlett: Usually that’s available at the end of your statements. So if you look at your statement from the bank, often they will give you a summary for the end of the financial year, or if you log into your internet banking, they’ll give you an interest summary and that will tell you what you’ve paid in interest for the year. And that’s the bit that’s deductible.
Janelle Bartlett: Now the other part’s not bad. It increases the equity that you have in that property.
So, it’s not a bad thing. It means that you’ve got more assets, you’re contributing to your asset base.
Ed Chan: Yeah. So as you’re reducing your loan on the property. Then your equity is increasing, meaning the bit that you own is actually increasing because, whilst you owe the bank the money, then you don’t, then the equity there is less, meaning that you owning less of the property itself.
Ed Chan: I often get this question, “Why can’t I claim the principal repayments to the bank?”
And my answer has always been, well, when you first bought the property you weren’t allowed to claim it as a tax deduction. So, therefore, when you’re paying the loan back, it’s also not a tax deduction.
Because it’s all part of the capital value of the property. So, often people find that difficult to understand, but that’s-
Janelle Bartlett: That’s right. Yeah, I think keeping that, as you say, keeping that mindset.
Some things are capital, some things are income. So the income, the rental, the running of the rental property is one side of it.
The capital and the ownership of the property is the separate thing. And that’s what the principal relates to. Yeah.
Ed Chan: Correct. Okay. Now here’s another really good one.
Often people will buy an investment property and they’ll rent it out and it’s an investment property and as long as you’re collecting the rent and it’s available for rental, then it’s all deductible.
But sometimes people live in the property themselves, sometimes the holiday letting, they might go in and live there.
Now if they do that, how is that treated? Because it has created a lot of confusion.
Mistake 6: Claim Rental Properties Not Genuinely Available for Rent
Janelle Bartlett: Well, basically the costs associated with the time frame that you’re in the property, so the interest and rates, anything like that, that covers the time that you are either living in the property or the property is not genuinely available for rent.
So, it can be you living in it. It could be that you’ve taken it off the rental market for renovation. That’s another thing. Anytime that it’s not genuinely available for rent, the expenses relating to that timeframe are not deductible.
Janelle Bartlett: In Queensland, one of the common things, is to have, say, a rental property on the Sunshine Coast, and we have to have it genuinely available for rent.
So people will put them into a rental pool with a ridiculous rent where they know it won’t rent and the ATO says no, that won’t cut it. That’s not genuinely available for rent.
Ed Chan: How do you prove that something is, firstly available for rental. What kind of evidence do you need to show that it has been available for rent?
Because as I understand it, as long as it’s available for rent and even if you don’t get a tenant in there, as long as it’s genuinely available for rental, then everything is still deductible.
Just to come back to what’s the evidence that’s required to prove that it is genuinely available.
Janelle Bartlett: I would say one good thing would be to have it listed with an agent.
So if you’ve got an agency agreement, generally an agent won’t list something if they don’t think they can actually rent it out for that price.
But, I would think that having an agency agreement and also having some supporting documents of similar properties or having a letter from your agent saying, “I think it will rent for this amount.”
So if the agent says, I think it’ll rent for, you know, between six and 700 and you put it on 700 that’s, I think that’s okay. I think supporting- don’t just come up with it yourself.
Ed Chan: And of course if you actually advertised it that’s another bit of evidence.
Janelle Bartlett: It is. I guess one of the things that people do is they advertise properties, but they’re not at market value.
So there, even though they’ve advertised it, there’s still no real prospect of a tenant to be interested in the property. So-
Ed Chan: So not only do you have to have advertised it to prove availability, but you also have to have advertised it at a market rental, not an over the top market rental that will never rent.
Okay. Yeah, that’s a real tricky one for many who often use part of their holiday home as a rental and around the holiday home.
All right, well that’s fantastic, Janelle. There was some really, really, really, really good questions there because, you know, it can cause so much confusion and, you know, hopefully, that’s helped clear up a few misunderstandings and mistakes that people potentially can make when they come to prepare their tax returns with investment properties.
So thank you again, Janelle, until the next time.
Janelle Bartlett: Thanks, Ed. Thanks very much for having me.
Ed Chan: Bye everyone.
Janelle Bartlett: Bye-bye.
About Chan & Naylor
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