The Government recently allocated additional funds to the ATO to extend its program of audits and reviews of rental properties.
ATO uses a range of detection methods including third party information such as collecting data from financial institutions, property transactions and rental bonds from all states and territories, and online accommodation booking platforms, in combination with sophisticated analytics to scrutinise every tax return.
They even search through the utilities, tolls, social media and other online content to determine whether the taxpayer was entitled to claims they've made.
Unfortunately, nine out of 10 tax returns audited in the past for rental properties were found having contained erroneous claims. That is apparently the reason for allocating extra funds this year, just for this purpose.
While the taxpayers are usually allowed to correct genuine mistakes without any penalties, the deliberate attempts to over-claim can attract penalties of up to 75% of the claim.
The key issues that the taxpayers need to pay attention are:
Loan interest to be calculated and/or apportioned correctly
If a taxpayer took out a loan to purchase a rental property, they can claim interest (or a portion of the interest) as a deduction.
However, if they use some of the loan money for personal use, such as paying for living expenses, buying a boat or going on a holiday, the interest on that part of the loan cannot be claimed to reduce the taxable income. They can only claim the part of the interest that relates to the rental property.
Capital works and repairs need to be separated carefully.
Repairs or maintenance to restore something that is broken, damaged or deteriorating are deductible immediately.
Improvements or renovations are categorised as capital works and are deductible over a number of years.
Initial repairs for damage that existed when the property was purchased, such as replacing broken light fittings or repairing damaged floor boards, cannot be claimed as an immediate deduction, but may be claimed over a number of years as a capital works deduction.
In other words, anything that replaces something or makes the economic life longer around the property, is a capital spending. This doesn't include some minor replacement such as changing the broken roof tiles, or leaking taps. However, replacing the whole roof or installing a new kitchen are capital works.
A holiday home is different to a rental investment property - a holiday home is generally a private asset used for family holidays, for which the taxpayer cannot claim expense deductions.
However, if a taxpayer lets their property out at 'mates rates' (i.e., below market rates to family and friends), they can claim expenses up to the amount of income they receive.
If the property is genuinely available for rent it becomes more like a rental investment property, and the taxpayer can claim deductions for the days it is either rented or is genuinely available.
The key point is, in either case, the rental terms and conditions need to be documented with a proper lease agreement. The holiday home is no different than any other rental properties when it comes to include it in the tax returns. Substantiation is essential.
If the taxpayers are unable to produce receipts or other documents to support a claim, the ATO disallows those claims in case of an audit. So simple.
Furnishing fraudulent or doctored records will attract higher penalties and may also result in prosecution. Don't even think about it.
Dealing with disasters - Damaged or destroyed property
For taxpayers whose income-generating investment properties are damaged during a natural disaster, the ATO has a range of support, advice and guidance available.
If an income-producing asset, such as an investment property, is damaged or destroyed in a natural disaster, the taxpayer will need to work out the correct tax treatment of insurance payouts they receive and their costs in rebuilding, repairing or replacing the assets.
The impacts of a natural disaster may affect the types of expenses taxpayers can claim and the income they need to declare for their rental property.
For more information, contact our office.