The most overlooked investment property deductions

One in five of us own an investment property, with 56.7% of Aussie wealth held in housing (at June 2023). It is an incredibly attractive investment option for many investors due to the capital growth that investors have historically seen in property. This is boosted by favourable tax treatment through policies such as negative gearing and the capital gains discount.

However, there are complexities to the administration and tax around investment properties. This complexity means that some investors are not maximising their total return.

In this article, I have leaned on insights from property tax expert Andreas Kyriacou, Senior Manager – Business and Private Client Advisory at SW Advisors.

Figure: Andreas Kyriacou, SW Advisors. Source: Supplied.

He has shared his thoughts around how to optimise a property investment, and pitfalls for investors to be aware of.

The most overlooked tax deductions for investment properties

Andreas shares that although the headline deductions may be common knowledge, there are nuances to each that means that investors may not be maximising their deductions.

Focusing on optimising these deductions will improve the total returns that investors get from their investment properties.

Depreciation on buildings and assets

Many property owners forget to claim depreciation on the building structure and assets, such as fixtures and fittings. Obtaining a professional depreciation report from a qualified quantity surveyor is essential to claiming the maximum allowable deductions.

Depreciation allows property investors to claim the wear and tear on both the building structure and its assets over time. It is one of the largest deductions that investors can make and are treated differently.

Capital Works Deduction (Division 43): This applies to the construction costs of the building itself (such as walls, floors, and roofing). Properties built after 1985 are eligible, and deductions can be claimed over 40 years at a rate of 2.5% per year.

Plant and Equipment (Division 40): Items such as appliances, carpets, blinds, and air conditioning units can be depreciated over the effective life of each asset. A professional depreciation report from a qualified quantity surveyor is highly recommended to ensure you maximise these deductions.

Settlement adjustments

If you have recently purchased or considering purchasing a new property, it is important to understand that you can claim some of the settlement costs. These are costs such as council rates, water rates, and body corporate fees. These costs are often shared between the buyer and seller, but the portion relating to the period after you take ownership is tax-deductible.

Interest on loans

The interest paid on loans taken out to purchase an investment property is fully deductible. However, some investors overlook that this also includes loan interest during periods where the property was not tenanted, as long as it was genuinely available for rent. Andreas also calls out that this is usually one of the largest deductions for investors. As long as the loan is used for the income-producing purpose of buying or maintaining the property, all interest payments are fully deductible.

Borrowing expenses

These are costs associated with securing a loan, such as loan establishment fees, mortgage registration fees, and stamp duty on the mortgage. These costs can be deducted over a five-year period.

Tax deduction ‘misconceptions’ that can shock property investors

There are several tax deduction misconceptions that can surprise property investors. Mainly, it concerns overclaiming or claiming upfront when it should be deducted over a longer time period. This can often mean that investors have to consider cashflow. Here are a few common ones:

Repairs vs. improvements

A common misconception is that all expenses related to repairing or improving a property are immediately tax-deductible. In reality, only repairs and maintenance that restore the property to its original condition can be claimed in the year they are incurred.

Improvements, which enhance the property's value or extend its life (like renovations or new additions), must be depreciated over several years. This misunderstanding can lead to cash flow surprises for investors expecting an immediate tax deduction.

Claiming deductions for private use

Some investors mistakenly believe they can claim expenses for the property even during periods when they or family members are using it for private purposes. However, expenses for times when the property is not available for rent, such as during personal use, cannot be claimed. Trying to deduct such costs can trigger audits and tax penalties.

Interest on redraw facilities and offset accounts

Investors often believe they can deduct all interest on loans used to purchase an investment property, but if they use a redraw facility or an offset account to pay for non-investment purposes, this may reduce the amount of interest deductible. Blending personal and investment funds can limit what can be claimed, which can be a shock at tax time.

Immediate deduction of borrowing costs

Some investors assume they can claim all borrowing expenses, such as loan establishment fees and lender’s mortgage insurance, as an immediate deduction. However, borrowing costs over $100 must be spread over five years or the life of the loan, whichever is shorter. This misconception can reduce the anticipated tax refund.

Depreciation on older properties

Historically second-hand assets were treated as a depreciating asset and the depreciation was tax deductible, however from 1 July 2017 that has changed, clients can’t claim the decline in value of second-hand depreciating assets, except for second-hand assets that are purchased for rental properties that are used for carrying on a business.

Claiming travel expenses

Some investors are unaware that as of 1 July 2017, travel expenses to inspect or maintain rental properties, or to collect rent, are no longer tax-deductible. Misunderstanding this rule can lead to claiming deductions that the ATO will disallow, causing unexpected tax adjustments.

Special levies

If your investment is a strata title property, you may come across some instances where you will be required to pay a special levy. These special levies can be significant amounts and result in significant cash flow issues. Adding to this, you can’t claim a deduction for a special levy you are required by the body corporate to pay to fund a particular capital improvement. You may be able to claim a capital works deduction for the cost of capital improvements or repairs of a capital nature once the work is completed. The cost must also be charged to either the special purpose fund or the general-purpose sinking fund, if a special contribution has been levied.

How to find a good accountant

Andreas advises that when selecting an accountant for investment properties, investors should prioritise accountants with specialised experience in property investment, particularly in tax deductions and capital gains tax expertise. The accountant should be across your investment strategy, offer proactive tax planning, and advise on optimal ownership structures. They should provide long-term financial advice, have transparent fees, and be available for ongoing communication.