Trustees of self-managed super funds that own vacation rental properties must take extra care when managing an asset that gets a lot of attention from the tax office around tax time. SMSFs risk breaching the in-house assets rule, as well making errors in their deductions.
The Australian Taxation Office keeps a close eye on deductions for rental properties because, it says, about 90 per cent of claims in this area contain errors.
Errors include incorrect interest claims for the entire investment loan where it has been refinanced for private purposes, incorrect classification of capital works as repairs and maintenance, and taxpayers not apportioning deductions for holiday homes when they are not genuinely available for rent.
Graeme Colley, executive manager SMSF technical and private wealth at SuperConcepts, says SMSFs also have to keep the in-house assets rule in mind.
Colley says that in cases where a fund member, trustee or one of their relatives use a rental property that is an asset of the fund, the value of the property may be included in the fund’s in-house assets.
“An SMSF’s in-house assets are limited to no more than 5 per cent of the value of is total assets at market value. A breach of the in-house assets test can result in penalties being imposed by the ATO and could require the sale of the rental property,” Colley says
The ATO provides guidance to help rental property owners avoid common tax mistakes.
Make sure the property is available for rent. The property must be genuinely available for rent before the owner can claim a tax deduction. The owner must be able to show a clear intention to rent the property, such as advertising the property. The rent should be in line with similar properties in its area and there should not be unreasonable rental conditions.
Portioning expenses. If your rental property is rented out to family or friends below market rate, you can only claim a deduction for that period in proportion to the amount of rent. You can’t claim any deductions for periods when friends or family stay in the property free of charge, or for periods of personal use.
If you own a rental property with someone else, you must declare rental income and claim expenses according to your legal ownership of the property.
Mortgage interest. You can claim interest as a deduction if you borrow to purchase a rental property. If you use some of the borrowing for personal use, such as going on holiday, you cannot claim that interest cost incurred during that period. You can only claim the part of the interest that relates to the rental property.
Borrowing expenses. Borrowing expenses include loan establishment fees, title search fees and the cost of preparing and filing mortgage documents. If your expenses are more than $100, the deduction has to be spread over five years. If they are less than $100, you can claim the full amount in the same year you incurred the expense.
Purchase costs. You can’t claim any deductions for the costs of buying your property. These costs, which include conveyancing fees and stamp duty, are added to the cost base of the property, which is used to work out any capital gains tax liability.
Repairs, improvements and construction costs. Ongoing repairs that relate directly to wear and tear or damage that happened as a result of renting out the property, such as fixing a hot water system, can be claimed in full in the same income year you incurred the expense.
Initial repairs for damage that existed when the property was purchased are not immediately deductible. These costs are added to the cost base and used to work out the capital gain when the property is sold.
Work such as replacing a roof or renovating a bathroom is classified as an improvement and not immediately deductible. These can be claimed at 2.5 per cent each year for 40 years from the date of completion. Likewise, capital works, such as extensions and alterations, can be claimed at 2.5 per cent of the cost over 40 years from the date the construction is completed.
Capital gains. If you make a capital gain on the sale of the property, you will need to include the gain in your tax return for that financial year. If you make a capital loss, you can carry the loss forward and deduct it from capital gains in later years.