With ongoing low interest rates it seems the hot property market won’t end any time soon. Hand in hand with that is also a boom in investment property ownership. The tax office has always shown a keen interest in investment properties but it has signalled it is specifically targeting this area in 2015 returns.

The emphasis is on making sure people aren’t over claiming deductions. In particular the ATO has said it is paying close attention to the following:

• Excessive deductions claimed for holiday homes
• Husbands and wives splitting rental income and deductions for jointly owned properties that is not supported
• Claims for repairs and maintenance shortly after the property was purchased
• Interest deductions claimed for the private proportion of loans

The ATO has also said it will be actively educating rental property owners about what they can and cannot claim. For example they will be writing to people with rental properties in popular holiday locations reminding them to only claim deductions they are entitled to for the periods the property is rented out or genuinely available for rent.

So how do you keep on the right side of the tax office if you have a rental property? The first thing they are looking for are accurate records. You need to be able to prove you are declaring the correct income and claiming legitimate expenses. At the least, this could mean supporting documentation like a real estate agent’s annual rental statement and receipts for all expenses. Secondly the ATO seems to be emphasising holiday homes (although the principle applies to all rental properties) where deductions can only be claimed for periods when the property is rented out or genuinely available for rent. Also if the property is rented below market rates, deductions are limited to the income earned while rented. Finally they are going to be looking closely at claims for repairs and maintenance which include expenditure which doesn’t qualify for an immediate deduction. For example renovation costs which will be depreciated over a period of time.

By way of illustration the tax office included the following case studies in their announcement, all involving disallowed claims.

Holiday homes: The ATO recently amended a taxpayer’s return to disallow deductions claimed for a holiday home after discovering that the taxpayer rented the home to family and friends during the year at less than market rate. Besides a brochure which was only available at the taxpayers’ business premises, there were no realistic efforts to let the property. The nightly rent advertised was much higher than that of surrounding properties. The pattern of income did not match the advertised rate, or the requirement for a five-night minimum stay. The ATO ruled that the property was mainly used for the taxpayer’s personal use, and deductions were limited to the amount earned from family and friends. The end result was that the taxpayer had to pay more tax and a penalty was imposed.

Husband and wives: The ATO has seen instances where a husband and wife jointly own a property but split the income and deductions unequally to get a tax advantage for the highest income earner. Some people have even included the income in the low income earner’s returns and the deductions in the high income earner’s returns. These types of arrangements attract higher penalties where we believe they have been done deliberately.

Refinancing: The ATO recently addressed a situation where a property was refinanced by a taxpayer to pay for their daughters’ wedding and an overseas holiday. The taxpayer claimed the whole interest amount, but should have only claimed the portion of interest that relates to the rental property.

Repairs and maintenance: A taxpayer recently claimed repairs and maintenance for a newly acquired rental property which was significantly improved upon purchase. The taxpayer provided an invoice from an interior developer for the “refurbishment” of the property. Further documentation detailed the scope of the refurbishment which included completely stripping the property and replacing old fixtures and fittings with new. The large repairs and maintenance claim was disallowed because initial repairs and improvements to a property are not deductible.

Rebuilding: A husband and wife demolished their existing rental property and built a new dwelling. In their income tax return they claimed an immediate deduction for their share of the entire cost of the building as repairs and maintenance. While the cost of constructing the new dwelling for rental purposes is permitted, the correct treatment is to spread the cost over 40 years, claiming 2.5 per cent of eligible construction costs as a capital works deduction. The repairs and maintenance claim was disallowed.

If you own a rental property, or are planning on purchasing a rental property, please come to see us if you are unclear about what deductions apply to your situation. We have been assisting clients with rental property investments for many years and can advise you on getting the best taxation outcome without falling foul of the ATO.