ATO warns property investors as interest propels tax refunds higher

Many of the nation’s 2.2 million landlords are claiming bigger tax deductions this year, but it’s not as lucrative as it seems.

Property investors’ tax refunds are rising while other Australians’ returns shrink, but the surge in deductions this year means many landlords are struggling with higher costs.

Interest costs on investment property loans have climbed after the Reserve Bank’s dozen interest rate rises between May 2022 and June 2023, while higher house prices are pushing up other deductions.

However, it does not mean Australia’s 2.2 million landlords are swimming in extra cash, with their costs generally rising faster than their rents, and the Australian Taxation Office has issued a fresh warning about dodgy rental property deductions.

ATO assistant commissioner Tim Loh said “we’ve seen an increase in interest claims for rental properties, which is not surprising after the number of interest rate rises during the 2023 financial year”.

ATO assistant commissioner Tim Loh says interest claims have climbed. Picture: Supplied

Interest is not the only larger tax deduction this year. Surging construction costs have pushed up the size of annual capital works deductions that typically total 2.5 per cent of a dwelling’s building cost. Insurance premiums – another deductible expense – also climbed sharply in 2022-23.

Higher landlord tax deductions this year are in contrast with broader tax time data. The latest ATO figures show half a million fewer refunds have been paid since July 1, reflecting the end of a popular tax offset last year and fewer working-from-home deductions following the pandemic.

The ATO says as of August 27, more than 6.2 million people had lodged their tax return and 4.7 million refunds were paid. At the same point last year 5.2 million refunds had been paid from 6.4 million returns lodged.

While the bigger refunds for property investors are helpful, they do not hide the fact that many landlords are losing money – because the nature of negative gearing means they only receive their marginal tax rate back for every dollar of deduction claimed.

Repayments on variable-rate mortgages have surged 58 per cent since mid-2022, while PropTrack figures show average rents rose almost 12 per cent nationally last financial year.

BMT Tax Depreciation chief executive officer Bradley Beer said while investors were paying more interest and getting bigger deductions, “if rates come down that should come down”.

Rising property prices were pushing up rental property deductions because loan sizes were larger, he said.

“Construction costs are going north,” Mr Beer said.

Landlords, like all taxpayers, were seeking bigger tax deductions to help offset rising costs, he said.

“Rents have gone up, but interest payments have gone up more,” he said.

“When people were paying 2.5 per cent interest, the rent was covering all their costs and it wasn’t hurting as much.”

BMT Tax Depreciation CEO Bradley Beer says interest costs climbed faster than rents.

Mr Beer said an estimated 70 per cent of property investors did not maximise tax deductions, particularly around depreciation.

The chase for bigger tax deductions has sparked a new warning from the ATO for landlords to get their returns right, after it found nine out of 10 rental property owners were getting it wrong.

“Around 80 per cent of taxpayers with rental income claimed a deduction for interest on their loan, and this is where we’re seeing the biggest mistakes,” the ATO’s Mr Loh said.

“We’re particularly focused on that this year,” he said.

“You can only claim interest on a loan used to purchase a rental property to earn rental income. If you’ve used any part of your original or refinanced investment property loan to cover private expenses, like buying a new family car, or renovating the home you live in, you can only claim an interest deduction for the portion relating to producing your rental income.”

Mr Loh said landlords and tax agents also made mistakes around over-claiming expenses or claiming for improvements to private properties.