1. Excessive deductions being claimed for holiday homes

Remember deductions can only be claimed for the periods the property is rented out or is genuinely available for rent.

Further, deductions should also be limited to the amount of income earned by the landlord when the property is rented to family or friends below market rates. The following case study from the Tax Office warns of deductions potentially being disallowed when taxpayers do not limit their deductions to the amount of income they earn from such an arrangement.

“The taxpayer rented the home to family and friends during the year at less than market rate. They also provided us with a brochure about the property but the only place the brochure was distributed was at their business premises, which did not have a large clientele. The nightly rent advertised was much higher than that of surrounding properties, and the pattern of income did not match the advertised rate, or the requirement for a five-night minimum stay. The deductions in this case were limited to the amount earned from family and friends because realistic efforts to let the property were not made – rather, the property was mainly for the taxpayer’s personal use. This meant the taxpayer had to pay more tax and a penalty was imposed.”

The Tax Office has also found instances where husband and wife jointly own a property but split the income and deductions unequally to get a tax advantage for the highest income earner.

“Some people have even included in the income in the low income earner’s returns and the deductions in the high income earner’s returns,” the Tax Office said. “These types of arrangements attract higher penalties where we believe they have been done deliberately.”

The ATO is also concerned with repairs and maintenance costs incurred by a landlord shortly after the property is purchased. These are commonly referred to as “initial repairs” and are generally capital account and therefore not deductible.

The following from the Tax Office illustrates a typical scenario:

“A taxpayer recently claimed repairs and maintenance for a newly acquired rental property which was significantly improved upon purchase. The taxpayer provided an invoice from an interior developer for the “refurbishment” of the property. Further documentation detailed the scope of the refurbishment that included completely stripping the property and replacing old fixtures and fittings with new. The large repairs and maintenance claim was disallowed because initial repairs and improvements to a property are not deductible.”

Interest expenses incurred with respect to a rental property are only deductible to the extent that the property is being used to produce rental income. Any interest expense referable to any private use of property is non-deductible.

“Say you live privately in a two-storey house on the Gold Coast. Both storeys are suitable for living – they have kitchens, bathrooms, etc. – and you decide to lease the empty top storey to students studying at a university nearby while you continue to live on the bottom floor. If you rent out 50% of your house – top floor – to the students, you can only claim 50% off the interest expenses on your mortgage and other relevant expenses. What you can’t do is claim 100% of the expenses on that house.”

It is vital that taxpayers with rental property interests get their deductions and expense claims right – if they don’t, whether by error or by design, they may face harsh penalties.