Changes to Rental Property Deductions

• August 2004

As you may know, a draft taxation ruling has been issued by the Australian Taxation Office that is set to change the effective life of depreciating assets in residential properties, while adding new assets to the list. Effectively, this will mean that first year deductions claimable by the average purchaser of a $400,000.00 new or near-new property will be approximately $6,000.00 - $8,000.00 less than previously received.

We understand the considerable impact this will have on property investors and have prepared the following information to assist you with the strategic decisions you will need to make about your present and future property in the new financial year.

Application of the Draft Taxation Ruling
The draft ruling will only apply to residential rental properties, which encompasses a house, an apartment, a unit or a flat, leased as residential accommodation.

It does not apply to:

(a) An hotel, a motel, a resort or similar property providing short-term accommodation (as part of one of those properties); or

(a) A caravan, houseboat or other mobile home.

The Key Changes A revised list of 230 residential property assets and their proposed effective lives has been produced by the Australian Taxation Office.

The list derives from a reconsideration by the Commissioner of the meaning of 'plant', 'articles' and 'machinery' for the purpose of making deductions, and the interaction of Division 40 (dealing with such deductions) and Division 43 (relating to capital works). This interaction indicates that where depreciation deductions are not available, other deductions may still be obtainable, and you should discuss this with us in more detail.

Under the new regime, certain fixtures such as vanity basins and basic towel rails will be excluded from the list, while other appliances such as dishwashers and rangehoods will be added. Significantly, the depreciation rates of many items will also change, marking important changes to how deductions will be calculated.

Common Deduction Mistakes
Further guidance to the deductions regime can be gleaned from the following list of the most common errors made by rental property owners, as identified by the ATO:

  • Claiming the cost of carrying out initial repairs - such as rectifying damage, defects or deterioration that existed at the time of purchasing the property - as immediate deductions. These costs are capital expenditure and may be claimed as capital works deductions over either 25 or 40 years, depending on when they were carried out.
  • Claiming construction costs, which are eligible for capital works deductions, as decline in value deductions (previously known as depreciation)
  • Claiming renovation costs as deductions for repairs - again, these are expenses of a capital nature and may be claimed as capital works deductions.
  • Including the cost of the land in capital works deductions (i.e. as part of the cost of constructing the rental property).
  • Overstating interest deductions by including amounts related to private borrowings - interest on a loan taken out for both income-producing and private purposes, such as the purchase of a rental property and a private motor vehicle, needs to be apportioned into deductible and non-deductible parts, according to the amounts borrowed for the rental property and for the private purpose.
  • Not apportioning travel costs where a visit to inspect the rental property is combined with another purpose, such as a holiday.
  • Claiming deductions for a property that is not genuinely available for rental or not apportioning deductions where the property is rented for only part of the year.

Rationale of the Draft Ruling
The purpose of the ruling is to bring greater certainty to the claims process for tax deductions for depreciating assets and thereby reduce overall costs and errors, and make risk assessments more practicable. The ruling remains in draft format and has opened for professional and industry comment until the 13th August 2004. This means that for the time being, it should not be relied upon for taxation purposes.

Nevertheless, you should keep the provisions of the ruling noted above in mind when dealing with all residential investment property, as the new effective lives will apply to assets acquired from 1 July 2004.

As mentioned above, we have attached a copy of the proposed list of depreciating assets and the length of their new effective lives. If you have any concerns or doubts about any of the changes or their financial or fiscal implications, you should consider your position carefully and make the time to discuss this in detail with one of our experienced commercial solicitors. We will assist you in ensuring the certainty of your legal position, to help you maximise the profitability of your assets.

Published August 2004. This publication contains general information. It is not intended to be a definitive analysis of legislative or other changes and professional advice should be taken before any course of action is pursued.