Warning to landlords: the tax office is cracking down and a wrong claim could be costly

If you are still trying to claim travel expenses and depreciation then it’s time to get some sound advice as the ATO is watching and your claim could turn out to be very expensive.

The ATO has released a warning that all landlords should take notice of.

It has been a tough few years for investment property owners.

The Victorian government has made sweeping changes to land tax, tenant rights and introduced a vacant property tax, while in NSW the latest state budget announced a freeze on the land tax threshold – meaning more investment property owners will pay land tax, to the tune of $1.5bn over the next four years.

After 13 RBA cash rate increases since May 2022, most investment property owners have seen their out-of-pocket costs increase significantly. As such, the temptation to get creative with tax deductions in an attempt to reduce the cashflow burden of sustaining an investment property is understandable.

However, the ATO is on alert and has released a warning that all landlords should take notice of.

It warns that “the ATO receives data from a range of sources like banks, land title offices, insurance companies, property managers and sharing economy providers, and cross checks this data to determine the accuracy of tax returns lodged by rental property owners”.

If you do not claim the right amount of tax deductions, there is a good chance that, via the data cross checking process, you will get caught out.

ATO assistant commissioner Rob Thomson says: “Rental property investments and taxation can get tricky, so it pays to get the right advice from the very beginning. Don’t rely on things you hear at a Sunday afternoon barbecue.”

Even though the change occurred seven years ago, it is surprising how many investors are not aware that you can no longer claim travel expenses to inspect and maintain rental properties, nor can you claim depreciation expenses on fixtures and fittings unless you purchased the property brand new, or incurred the expense yourself.

In other words, a property that is a few years old with fixtures and fitting on a 10-year depreciation schedule can only be claimed by the original owner. Subsequent purchasers are limited to claiming depreciation on the building at a rate of 2.5 per cent over a 40-year period.

And if you renovate an investment property, be wary of claiming the whole cost in a single tax return.

“A repair can usually be claimed straight away but capital items, think dishwashers, curtains or heaters, can only be claimed immediately if they cost $300 or less, otherwise they need to be claimed over time,” Mr Thomson says.

Interest on loans makes up the largest proportion of property deductions, representing 42 per cent of claims, so there is no surprise that the ATO keeps a close eye on this area. In its warning it highlights a common issue whereby the full amount of interest on an investment property loan is inaccurately claimed.

Even if your investment loan was used to purchase your investment property, it may not be 100 per cent tax deductible. If you have personal use of the investment property, such as in school holidays if it is a short-term rental, you need to apportion the private use and reduce your interest expense tax deduction.

In addition, if the investment property loan has been used for any purpose other than purchasing the property, this needs to be factored into your tax return.

“If you have an $800,000 mortgage for a rental property and then add $50,000 to the loan to upgrade your family car, you can only claim the interest on the initial $800,000, not the interest on $850,000,” Mr Thomson says.

The same goes with claiming other private expenses against investment properties.

The ATO gives the example of a Melbourne investor who tried to claim two cooktops as a tax deduction. The ATO picked up that the investment property only had one kitchen and that the second cooktop had been installed in the landlord’s own residence.

The outcome was the ATO adjusted the tax return and made the rental property owner pay penalties and interest.

Apartment owners also get a mention by the ATO regarding strata fees and special levies. If the body corporate requires payment to a special-purpose fund to pay for a particular capital expenditure like replacing the roof of an apartment building, these levies are not deductible until the capital works are complete and the expense has been billed to the body corporate.

In one small win for investors, if you own an investment property in the ACT you can claim the stamp duty as a tax deduction, however in all other states and territories you can only use it to reduce capital gains tax upon sale.

While owning an investment property is still a valid way for people to build wealth – and there has been steady long-term growth rates in most capital cities – investors need to be meticulous with their record keeping and only claim tax deductions within the allowed framework to avoid the attention of the ATO, which is clearly are cracking down on property investors.

James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au