With more and more people choosing to invest in residential property, understanding the obligations and entitlements of receiving rental income is very important to ensure that you get the best return from your investment.
The Australian Taxation Office (ATO) has recently released the 2011 Guide for Rental Property Owners and also held a series of seminars to discuss with tax practitioners the various issues relating to the taxation of rental properties.
Below we look at some of the less well known deductions and entitlements in relation to residential rental properties.
Capital works deduction
If the rental property was constructed after July 1985, you may be entitled to claim a ‘capital works deduction’ for the property.
The capital works deduction allows rental property owners to claim the cost of construction over a period of 40 years (25 years in some cases). The deduction only relates to the cost of construction (i.e. the building) not the value of the land. Say you make additions to the property of a capital nature, for example the adding of a carport or extension, this expenditure is added to the cost of the property rather than being immediately deductible and would also qualify for the capital works deduction.
There are two main ways to determine the construction expenditure for a property.
It is important to know that the capital works deduction reduces the cost base of your property which will lead to an increase in the capital gains tax liability if you decide to sell the property. For example if you purchase a property for $500,000 and over a period of 10 years, claim $10,000 in capital works deductions, your cost base for the property would be reduced to $490,000.
Decline in value deduction (Depreciating assets)
The legislation allows rental property owners to claim for the decline in value of depreciating assets within the property.
Assets such as furniture, carpet, curtains, appliances, fittings and fixtures are all considered depreciating assets.
If you purchase a rental property with these assets included, it is advisable to engage the services of a quantity surveyor to provide an independent assessment of the value of the each of the assets. The cost is generally between $300 and $700 but can be very worthwhile in ensuring you maximise the benefit of the deduction.
Capital Gains Tax (CGT)
Profit on the sale of a rental property will in the majority of situations be liable for capital gains tax (excluding properties purchased prior to 19 September 1985).
Any profit that you make on the sale of the rental property must be included in your assessable income for the year in which the sale occurred. Profit on sale is determined by sale proceeds minus cost base minus the 50% general CGT discount if the property has been held for 12 months or more.
It is also important to remember that the small business CGT concessions are not available on the sale of a rental property as property investment is determined to be a passive investment rather than an ‘active’ asset.
Main residence exemption
The ‘main residence exemption’ excludes a property from capital gains tax if the property is the primary place of residence of the owner (ie. the family home).
This exemption has some application to rental properties as a property can be rented out for up to six years and still be determined the principal place of residence of the owner (as long as you do not own another principal place of residence during this time).
The ‘main residence exemption’ can be useful where an elderly family member moves into an aged care facility. Even though the family member may live in the aged care facility, their family home can still be considered as their main residence and can be rented out and not become liable for capital gains tax when it is eventually sold, as long as it is within the six year period.
The legislation in relation to rental properties is complex and deductions are closely scrutinised by the ATO. A list of 'Immediately Deductible Expenses' is shown below. For more detailed information please speak with your local Boyce Accountant.
Download the ATO Guide for Rental Properties 2011 here.
Ian Horsburgh, Accountant—Boyce Dubbo
