Maximise deductions after living in an investment property
Discover the taxation and depreciation implications of living in an investment property
This time last year, experts were predicting impending doom for the property market. Plunging property values, falling rents and record-breaking high vacancy rates were just some of the disaster scenarios mentioned.
As banks and the government rushed to safeguard Australians’ livelihoods and the national economy, The Australian Prudential and Regulation Authority (APRA) found that almost $40 billion in loans were either overdue or had defaulted in the quarter ending June 2020.
Moving along to 2021, we are seeing house prices strengthening, interest rates remaining low, and the property market’s path forward beginning to clear. Investor loans are starting to recover. The Australian Bureau of Statistics’ (ABS) Lending Indicators data revealed that loan commitments for investment properties rose 8.2 per cent in December 2020, reaching $6 billion.
The unprecedented times and turbulent market has resulted in many investors reassessing their financial and investment strategies.
One of the more interesting trends that we have seen here at BMT is an uplift in people converting their homes into investment properties. Throughout 2020, more than one in every four schedules BMT prepared were for properties that had been previously owner-occupied. We have also received enquiries from investors looking to do the reverse and make their rental property their main residence.
Whichever side of this story an investor is on, there are several taxation and depreciation implications to be understood.
The first scenario of turning a main residence into an investment property can be an affordable and popular way to enter the investment property scene. It can be a good option if the owner wants to hold onto the property rather than selling in an unpredictable market, while taking advantage of longer-term capital growth.
From a financial standpoint, a lot will change. First and most importantly, is that the owner can now claim their home-ownership losses as tax deductions.
These deductions can climb into the thousands of dollars in just one financial year. The latest Australian Taxation Office (ATO) statistics reported some of the average deductions residential investors claim. The average interest repayment deduction is almost $9,500, body corporate fee deductions hit an average of almost $2,300 while the average land tax deduction is approximately $1,500 over a full financial year.
New costs associated with turning the home into an investment are also valuable deductions. The average property management fee deduction comes to almost $1,300, and the combined sundry and tenant advertising average deductions come to approximately $1,000.
The homeowner can also begin claiming depreciation on the property’s natural wear and tear. Depreciation works slightly differently as it’s a non-cash deduction, so they don’t need to spend any money to claim it.
A plant and equipment asset is defined as mechanical or easily removable from the property. Key examples include hot water systems, smoke alarms, blinds and carpets. For previously owner-occupied properties, any used plant and equipment assets will be ineligible for depreciation, but new assets purchased for the property can be claimed only while it’s an investment.
The homeowner will also be able to claim any eligible capital works deductions on the wear and tear of the property’s structure and fixed assets such as doors and built-in cupboards. Capital works make up on average 85 to 90 per cent of total depreciation claims.
The average claim for both plant and equipment and capital works reported by the ATO was $3,835, while the average deduction found by BMT in the same period was $8,540.
The table below demonstrates the depreciation deductions a homeowner could expect from turning their home into an investment. These averages have been calculated from an analysis of all BMT schedules prepared in 2020 for investment properties that were previously owner-occupied.
|Property Type||First full financial year deductions||Cumulative 5-year deductions||Total|
|House with granny flat||$11,853||$60,553||$386,784|
The taxation outcome becomes less appealing when an investor does the opposite and decides to move into an investment property. Whether it’s for the short term or they plan to make it their ‘forever home’, it’s key to understand how it all works.
From the moment the property is no longer available for rent, the owner won’t be able to claim any expenses or depreciation deductions. If they are only planning to live there in the short-term and rent the property out again, claimable losses will stop and then restart when the property begins to produce income.
For each given scenario when a property starts to produce income, a capital gains tax (CGT) liability could be triggered when the property is sold. The CGT outcome will be affected by a variety of circumstances at the time of the CGT event.
When determining any payable CGT, an accountant will need to consider many factors including the purchase price and market value at the time the property started to produce income, cost base, time of sale and previous deductions claimed.
They will also assess if any of the CGT discounts and exemptions apply including the 50 per cent discount, main residence exemption, six-month rule and six-year rule. A key element of determining if any of these apply is the length of time the property was a main residence or used as an investment.
No matter what the situation is, it’s always worthwhile to get a depreciation estimate for an investment property. A BMT Tax Depreciation Schedule ensures all legislative requirements are followed and deductions are maximised. Even if the property only produced income for a short period of time, there can be substantial deductions available.