While many first-time homebuyers are motivated by the dream of living in a house owned by them, some may prefer to invest in a home but not live in it.
Buying an investment property has several potential advantages for the homeowner beyond earning rent to help repay the mortgage.
Homeowners can claim a tax deduction on the cost of “capital works” such as construction or renovation if the home is either rented or made available for rent. They may also qualify for tax deductions on “capital allowances” or expenses towards “depreciating assets”. Such assets are the items in the rental property that tend to decrease in value with use, over time.
What are the tax deductions on capital works available to owners of rental properties?
Whether you buy a newly developed property or a previously owned home, you may need to repaint the house or put in a wall to create more rooms before renting it out. As per the ATO, improvements must clearly and positively impact either the use or the rental value of the home. Typically, for homes built after 1987, owners may qualify for a tax deduction worth 2.5 per cent of the construction cost for the duration the house is rented, up to a maximum of 40 years. Note that this duration is measured from the completion of the construction work.
Likewise, owners may claim a tax deduction for structural improvements to a rental property, which is also 2.5 per cent of the improvement cost, but only if the improvements were made after 1992. Both these deductions can only be claimed for the time the homeowner rents out the home. The homeowner will need to provide details of the construction or improvement work, including the type of work undertaken and who performed it, the start date and completion date, and the total construction or improvement costs.
If receipts are not available for the construction or improvement costs, owners can submit an estimate prepared by a qualified expert. They can also include the fees paid to contractors, architects and even the qualified expert preparing the cost report in the costs on which the tax deduction is claimed. The homeowner must include details about the period during which the home was rented out when claiming a tax deduction.
What tax deductions can rental property owners claim on depreciating assets?
Homeowners often rent out homes that are equipped with, for instance, electrical appliances or home furnishings. These are called depreciating assets as their value declines over time. However, for tax purposes, only assets that are not permanent installations but distinct from the building, and that may need to be replaced within a defined period of time are considered depreciating assets. Typically, a surveyor or another expert can prepare a schedule of depreciable assets listing the original value of the assets, their estimated life and the expected decline in value.
Usually, homeowners can only claim a tax deduction for newly purchased assets. Consider checking the full list of depreciating assets on which the ATO allows tax deductions. They can also claim a tax deduction on assets valued at under $300 in the same tax year the home was rented out. If the cost of several assets doesn’t exceed $1,000, homeowners can claim a tax deduction on these assets collectively.
For more expensive assets, homeowners may claim a tax deduction over several years using either the diminishing value method or the prime cost method. Homeowners who want to claim more deductions earlier can opt for the diminishing value method, while those preferring equally proportioned deductions over the life of the asset can use the prime cost method.