Podcast: Common Tax Return Mistakes Part 2

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Ed Chan and Janelle Bartlett continue their talk on common tax return mistakes property owners and investors make.

Avoid these common tax return mistakes. Learn more about them here. Watch the video, listen to the audio, or just read the transcript below.

If you missed Part 1, head on to this page.


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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.

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.

Okay. So the other common mistakes that people make is around withdrawing on their line of credit and using that money for something other than the investment property.

How is that normally treated? And perhaps just give us an example.

Interest on Home Loan Redraws Is Not All Deductible

Janelle Bartlett: It’s pretty common and line of credits are very common with this and even loans just with a redraw facility. So we might not call it a line of credit as such, but it has a redraw facility.

Janelle Bartlett: So a client might have a loan that they’ve used to purchase the rental property and it might, over time, build up some capacity too, so you know, some excess where they’re able to redraw on that loan.

If they redraw on the loan for a private purpose, then the entire interest is not deductible, and it kinda gets worse. So, for example, if you’ve got a $500,000 facility, you’ve got your mortgage is down to 400,000 on your rental property and you’ve got a 100,000 there in capacity that you can redraw on.

If you redraw on that and go and do something private with it. And it’s generally less than that, it’s usually something like 20,000 and they go overseas or- then one-fifth of the interest, in that example, 100 is used for another purpose of a $500,000 loan.

Janelle Bartlett: So one-fifth of that interest is not tax-deductible and, it gets worse, because clients say to me, “Okay, well I’ve paid it back.” The ATO won’t allow you to pay that $100,000 back against just the private part. They say when you pay it back, you pay one-fifth of it against the private part and four-fifths of it against the rental property part.

Janelle Bartlett: So when money goes back in as a repayment, it has to be apportioned across. And then if you redraw, that proportion changes.

It becomes quite a complicated calculation and it’s expensive to calculate it and get it right.

So my suggestion is, do not redraw for private purposes on your rental property loan. If you really must, go to the bank and have that loan refinanced, and finance a separate private loan so that can, they can be kept quite separate.

And when you refinance, make sure that it’s only the original amount of the loan and the loan costs. So don’t, if you’re going to refinance that 400,000 don’t go and get a loan for 450 it can only be 400 plus the costs of refinancing.

Ed Chan: Okay, so that’s a really tricky one. It’s probably simpler to just, instead of redrawing, it’s probably simpler to use an offset account.

Janelle Bartlett: Yes, at the outset.

Ed Chan: Yeah. Put your excess cash into an offset account.

So that, for those of, for those of you who don’t understand what an offset account is, is that instead of paying down the loan, you park the extra cash that you have that would have been used to pay the loan down, you park it next to the loan itself so that the interest that’s on the cash is calculated and not payable on the loan itself.

So it’s a much more tax-effective way of using your redraw facility or your line of credit. So that’s a very, very tricky one.

Janelle Bartlett: It doesn’t cause any problems. You can redraw your offset account with no consequences to the tax-deductibility of your interest. That’s exactly the answer.

Ed Chan: Okay. All right. Another tricky one for the average punter out there is around capital improvements.

Janelle, can you explain the capital improvement situation?

Improvements on Properties Are Not Claimable

Janelle Bartlett: Yes. We see a lot, you know, clients will come in and say, look, we spent $25,000 replacing the roof, so this is going to be great. You know, we’re going to get a big tax refund.

The bad news is that they’ve replaced the entire roof and that is a capital item. It depreciates at two and a half per cent.

So the 25,000 is going to be written off over a very long period of time. Over about 40 years. So it’s thinking that that is a claimable amount.

Janelle Bartlett: And it’s interesting, there’s a whole lot of case law about what is an item and what is part of an item.

So if you, for example, in a kitchen, if you pull the kitchen out and you replace the kitchen, that’s for capital upgrade and most of that is going to be at two and a half per cent.

However, if you just take the benchtops off and you repaint. We get one of those coating guys into to refinish the cupboards, that’s a repair.

So it’s, sometimes it’s just being really smart about the way you do things. Sometimes you can’t do that, you just have to replace the whole thing.

But when you do that, remember that you’re not going to get a tax deduction in the year that you spend the money.

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Ed Chan: Okay. Just to clarify and give it a bit of context.

So, if someone can claim it as a repair, they can claim 100% of it in the year that it was incurred. But if the capital item, you can only claim two and a half per cent of it for 40 years.

Ed Chan: You can see the difference of why people are always trying to classify it as a repair, which is 100% deductible, versus if it’s a capital, you only get two and a half per cent.

Janelle Bartlett: Exactly, right. Yeah, that’s right.

Ed Chan: And those things that you’ve just talked about come into play.

So if you improve the item or replace the whole item, then it’s a capital item, but repair or fix a portion of that item, or you put it back to what it used to be. It’s a repair. Yes.

Janelle Bartlett: So again, you can’t put a stone benchtop on where there was a laminated benchtop. You’ve got to stick with a laminated benchtop.

Ed Chan: Correct. But that’s an improvement as opposed to replacing a wooden fence with a stone fence. That’s an improvement. And that’s a capital item. Okay. Yes, it’s a lot of debates over that particular one.

Janelle Bartlett: Oh yes. There’s a lot of case law about that. Yeah, that’s right.

Ed Chan: Thank you for clarifying that because that’s another very confusing item around deductions. All right, I’ve got another one.

What about the treatment of body corporate fees and special building fund? Perhaps if you start off by explaining how they occur and then go into explaining how to treat it.

You Can’t Claim All Body Corporate Fees and Special Building Funds

Janelle Bartlett: Okay, so body corporate fees and special building funds relate to properties that are part of a group.

So part of a group title or a body corporate title, so tends to be an apartment block or a townhouse, something like that. Where there’s a body corporate that looks after some of the common things.

And so, the job of the body corporate is to look after things like common lighting, gardening, the cleaning of all the exterior. It can be the insurance to the building as well. So, there are fees that are charged by the body corporate to keep all that going and they tend to be in two types of categories.

Janelle Bartlett: The first one, is just the normal administration.

So you might have a body corporate manager. Who earns a fee, is paid a fee. There’s lighting, the garden guy, the repairs and maintenance to the lighting around the place and, you know, fixing the driveway. All the ongoing sort of little things that happen and the owners contribute to that in proportion.

So the whole property is broken up into lot entitlements and if you have a larger property you will have more lot entitlements and so all of your bills are based on that lot entitlement.

Janelle Bartlett: Now, there’s also a building fund.

Now, your average building fund, it really depends, we really have to have a look at it, but the ones that are of most concern are the special building funds.

For example, a client that comes in to see us, as they did last year, and said, “Look, we’ve got this special building fund. We’ve just put $20,000 into it.” It’s to replace the roof of the apartment block that they have a rental property in.

Now that’s not tax-deductible. That’s actually a capital item. So we’ve got to be careful of that.

Now building funds fall either side, we’d really have to have a look at it. Your ongoing little things, building funds that are contributing a constant amount are okay. They’re usually deductible. The ATO’s put out a ruling on that, but these special building funds are not.

Ed Chan: All right. Perhaps it’s probably appropriate now to say that obviously, if you don’t want to get into trouble it’s obviously better to use an accountant to help out and we’re available to do that.

All right, and the very last question, Janelle, and I’ll let you go, and that’s around record keeping.

Often if you buy an investment property, you don’t want it to be a burden. What should we do around that? Let’s upload our tips.

Final Tips

Janelle Bartlett: Well, I guess the main thing is to make sure that we actually do keep the records that are needed. We need to keep records for five years.

So if we’re looking at things like rates and insurance that are on your rental property statement, so your rental statement in your income tax return. Then we need to keep those rates notices for five years.

Janelle Bartlett: However, with your purchase documents. We also use those when you sell a property. So you need to keep your purchase documents for five years after you’ve sold a property.

So you might own the property for 10 years, you need to keep those records for 15 years. And that includes your settlement letter from your solicitor, your stamp duty receipt, your legal costs, your contract, your purchase contract.

Anything at all that you spent- your building and pest, anything that you spent right at the start.

Janelle Bartlett: In terms of the way you keep your records, it’s really important that it’s something you’re comfortable with.

If you’re not comfortable with it, you won’t keep up with the system. Personally, I like a paperless system and the good thing about that is that you’re not at the mercy of, you know, receipts fading and you’ve lost them. Because you can actually keep them in a number of places.

So, for example, you might keep them on your personal laptop, in a particular folder that you can also copy that to your OneDrive or your iDrive and just make sure that you’ve got a backup of them.

I would always keep a scan of the receipts and keep them in folders for each year. So, for example, for the 2019 year, you would keep the receipts for rates, keep all the rates in a little folder called 2019 rates or 2020 rates and keep them in order like that.

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Janelle Bartlett: Keep a permanent folder, which is all your purchase documents. And keep scans of them.

A scanned copy of the document is perfectly acceptable. Also, keep proof of payment.

So every rental property should have or should be run through, a rental bank statement, a bank account that you keep, either for all your rental properties or for each rental property.

And I’d probably put them all through the one just to avoid some bank fees. But you need to prove payment too.

Janelle Bartlett: So, for example, if you spent something on rates, you’ve got your rates notice the [HR kins 00:00:26:57] also ask you to show that you paid that.

The sorts of things they likely to want to check are things like your purchase of, you know, repairs and maintenance and that sort of thing.

But any of those expenses they can actually ask to see the invoice and the proof that you’ve paid it.

Janelle Bartlett: So scan the documents and, you can use a number of ways, either scan at the scanner on your computer or use a scanner on your phone.

There’s a little app called Tiny Scanner and you can scan it and email it to a particular email address, maybe set up a rental email address, but do download them and keep them into organize files and folders and keep a backup of it.

So whatever you, everyone likes to use different things, some people use Dropbox, some people do use Google drive, whichever you use, make sure you keep a copy and you regularly copy it across.

Ed Chan: All right, that’s really good advice, Janelle.

I’m pretty lazy actually. I have quite a few investment properties and I tend to get the real estate agent to pay for all the expenses because of two reasons.

Ed Chan: One is that, you know, they’re not normally holding onto your rent and they don’t give it to you for, you know, a whole month.

And so when they pay for those expenses out of that trust account, they, you actually using that money instead of your own money, as a first thing.

Janelle Bartlett: That’s right. And then all you’ll…

Ed Chan: Yes. And the second thing is they send you a summary of all the rent that you receive at the end of the year, together with all the expenses.

And so I have all the rent and expenses all in one sheet. And I give that to the accountant. And it makes it very, very simple. And then, if I happen to spend, which I try to avoid, just spend money on the rental property out of my own pocket, I then simply give them a sheet of all the expenses that I’ve incurred, that has not been recorded in the real estates rental statements, so that it’s not confusing the accountant.

So you have a separate list of the things that you’ve actually paid out of your pocket, which I try to avoid for those two reasons. And then you have the statement from the real estate agent, which is just one page and it’s got the income and all the expenses and it makes the record-keeping very, very simple.

And also when it comes to tax time, it makes the job of your accountant much easier as well.

Janelle Bartlett: It certainly does too. And the week- and the monthly statements from your agent will also have a copy of the invoices that you need.

So not only keep the annual one, annual statement, that’s great for your accountant and it’s great for record-keeping. But if you keep all of your monthly statements from your agent as well, you’ll have all of the supporting documents that you need.

Ed Chan: Yeah, absolutely. And if you’re used to scanning things into your computer- Janelle, will the ATO accept a scanned copy of a receipt as opposed to…

Janelle Bartlett: I know they will, they will.

Ed Chan: Just to simplify it. You can just scan all those receipts and all those records into your computer and then throw the rest away and it’s nice and simple.

Janelle Bartlett: That’s right you can. Most people are pretty nervous the first couple of years. So if you’re that tight, really, the best idea is just to keep the paper copy as well. But trust me, as years go by, you will learn to discard the paper copies.

Ed Chan: Especially when the boxes in the garage are getting bigger and bigger.

Janelle Bartlett: [inaudible 00:30:26], that’s right.

Ed Chan: And the wife is getting cranky at you for having all these boxes. [crosstalk 00:30:30].

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

Chan & Naylor is Australia’s leading national property, business tax accounting and wealth advisory group – with national offices in South West SydneySydneyPymble and Parramatta in New South Wales, Wheelers Hill, MelbourneMoonee Ponds and Hawthorn in Victoria, Brisbane and Capalaba in Queensland, and East Perth in Western Australia that can assist property investors, small business owners, and entrepreneurs with their tax and accounting needs.

If you need help with your property investment, contact an Accounting Specialist to discuss your particular circumstances.

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