The Great Australian Dream: Investment Property 101

Welcome, to the Podcast! Our newsletter made easy! Please note, this podcast features AI-generated voices for your hosts, Mia Taylor and Leo Baker, bringing you expert insights from owner, Ben De Rosa, at Aevum Accounting. Each week, we're here to help you confidently navigate the ins and outs of Australian tax – whether it's for your individual finances, or the complexities of your business. We'll cut through the jargon to give you strategies for compliance, smart planning, and that ultimate peace of mind. So, if you're looking to understand your obligations, maximize your financial position, or simply gain clarity on your money matters, you're in the right place. Let's get started with our review of the week! Aaron Bergsma said "Aevum provides fantastic service for all your accounting needs. Ben is highly knowledgeable on all things tax related and goes out of his way to ensure he provides a service suited to your needs. Simple or complex, I couldn't recommend Ben and the team highly enough." Thank you for the amazing feedback Aaron! We love hearing from our clients and a positive review gets our podcast started on the right foot. And we are back! Leo Baker here, and today, Mia, we’re tackling a huge topic, something that feels woven into the very fabric of this country: investment properties! That’s right, Leo. It’s a cornerstone of wealth creation for so many Australians. But beyond the excitement of buying a property, there's a whole world of tax rules, deductions, and strategies that can make the difference between a great investment and a costly headache. It’s like buying a money-making machine. The goal is to have someone pay you rent to use it, while the machine itself hopefully becomes more valuable over time. But what people forget is that the machine needs maintenance, has running costs, and the instruction manual is written by the ATO, so… good luck with that. That is a surprisingly accurate analogy. So today, we’re going to simplify that instruction manual. But first, before we get to the deductions, we need to talk about income. It's not just the weekly rent you need to declare to the ATO. What else, is there? You also have to declare any other income associated with the property. This includes things like if a tenant pays for a repair that they caused and you keep that money, or if you receive an insurance payout for lost rent or damage. All of that is considered assessable income. Okay, so all the money coming in needs to be on the books. Now let's get to the fun part: the deductions. What costs can you actually claim against that income to reduce your tax? The most significant one for most people is the interest on the investment loan. On top of that, there are the direct running costs you can claim immediately: things like council rates, water rates, land tax, landlord insurance, and strata levies if it’s a unit or townhouse. What about the cost of getting the loan in the first place? Those application fees and mortgage broker fees can add up. Great question. Those are called 'borrowing expenses', and they're treated differently. You can’t claim them all at once. Instead, these costs are deducted over the term of the loan, or for five years, whichever is shorter. Okay, so that’s a slow burn deduction. What about things that break? If the hot water system gives up the ghost? That falls under 'repairs and maintenance', which are generally deductible in the year you pay for them. The key distinction the ATO makes is between a 'repair' and an 'improvement'. Replacing a broken fence panel is a repair because you are restoring something to its original state. But replacing the entire fence with a fancy new one is likely an improvement, which is a capital cost and treated differently. A huge trap for new investors is what the ATO calls 'initial repairs'. If you buy a property and it has pre-existing defects, like a rotten deck, the cost of fixing those defects is not an immediate deduction. It's treated as a capital expense because it's part of the initial cost of getting the property into a rentable condition. That is a massive trap! What about visiting the property? Can I claim a flight to the Gold Coast to check on my holiday rental? I’m afraid not, Leo. This is a common myth. The ATO is very clear that for residential rental properties, you generally cannot claim any deductions for the cost of travel you incur to inspect, maintain, or collect rent for the property. Wow, another myth busted. You've already mentioned a few traps. I bet the ATO sees the same mistakes from property investors year after year. Is there a list of common errors? There absolutely is, and running through them is a great way to stay out of trouble. Let’s play a game: The ATO's Top Tax Traps. First up is exactly what we just discussed: incorrectly claiming initial repairs or capital improvements as an immediate deduction. That’s a big red flag. Okay, what’s another one? Overclaiming interest on the loan. People assume all the interest they pay is deductible, but you can only claim the interest on the portion of the loan that was used for the investment property. If you have a redraw facility and you pull out, say, $50,000 to buy a new car or go on a holiday, the interest that accrues on that $50,000 is for a private purpose and is not deductible. You have to apportion your interest claim. That is a sneaky one! People do that all the time. They do. And the third big trap is simply poor record keeping. People think a bank statement showing a withdrawal is enough. It isn’t. You need to keep proper records – the actual invoices and receipts that prove what the expense was for. The ATO can deny claims if you don't have the evidence to back them up. Okay, so with all these expenses, I hear this term 'negative gearing' all the time. What does it actually mean? In simple terms, a property is negatively geared when your total deductible expenses are greater than the rental income you receive for the year, creating a net rental loss. You can then often offset this loss against your other income, like your salary, which reduces your overall taxable income for the year. The opposite is 'positive gearing', where your rent is higher than your expenses, creating a taxable profit. So, patching a hole is a deduction now, but building a whole new wall is something you claim over time? You've just perfectly set up our next topic. That "claiming over time" is called depreciation, and it’s one of the most powerful deductions. This is where the real magic happens, right? The so-called 'phantom deduction'? That’s what some people call it. Depreciation is the wear and tear on the building and the items within it. It’s split into two main categories. First, there’s 'Capital Works'. This is a deduction for the structure of the building itself – the bricks, roof, and wiring. For properties built after September 1987, you can generally claim this at a rate of 2.5% per year for 40 years. Second, there are the 'Plant and Equipment' assets. These are the removable items inside the property, like carpets, blinds, and ovens. However, and this is the most critical rule change in recent years, for second-hand residential properties that you acquired after 7:30 pm on 9 May 2017, you can no longer claim depreciation on any of the *existing* plant and equipment assets. Wait, seriously? So you can't claim for the oven and the carpets that were already in the house when you bought it? That's exactly right. You can still claim the Capital Works on the building itself, and you can claim depreciation on any *new* plant and equipment you buy and install yourself, but not on the items that came with the property. So how do you figure all this out? It sounds incredibly complex. It is, which is why you need a specialist report called a Tax Depreciation Schedule from a qualified Quantity Surveyor. They will assess the property and create a report that details all your eligible deductions for up to 40 years. The fee for this report is a one-off cost and is 100% tax-deductible itself. It is an absolute must-have. So that covers a separate investment property. But what about people who just rent out a spare room to a boarder or on Airbnb to help with the mortgage? That’s a huge area now, and it comes with very important tax implications. Firstly, you absolutely must declare the income you receive. Secondly, you can claim a portion of your household expenses, but it must be correctly apportioned. 'Apportioned'. How does that work? You generally work it out based on the floor area of the rented room as a percentage of your total home. For example, if the rented room is 15% of the floor area, you can claim 15% of your general household expenses, like council rates, insurance, and the interest on your mortgage. For shared spaces like the kitchen and living room, the claim is further reduced based on usage. Okay, that makes sense. You get some deductions to offset the income. What’s the catch? The catch is Capital Gains Tax. This is the big one. Your main home is normally exempt from CGT. But the moment you start using a portion of it to earn income, you lose that exemption for the same portion. So, if you use 15% of your home to earn income for the entire time you own it, then 15% of the capital gain you make when you eventually sell will be taxable. That extra cash from a boarder can come with a very big tax bill at the end. It really shows how everything is connected. Now, we've talked about individuals buying property. What about more complex ownership structures? That’s a great question. While many people buy in their own name, either solely or as joint tenants, there are other options. A common one is a Discretionary, or Family, Trust. The key benefit here is flexibility. The trust owns the property, and the trustee can decide each year how to distribute the rental profit to the beneficiaries – usually family members – in the most tax-effective way. It can also offer significant asset protection benefits. And what about the holy grail I hear about? Buying property inside your super fund? You can, through a Self-Managed Super Fund, or SMSF, but the rules are extremely strict. The investment must pass the 'sole purpose test', meaning it's solely for providing retirement benefits. You or a related party can never live in the property or rent it from the SMSF. The borrowing arrangements are also very complex and expensive. While it can be a powerful strategy for the right person, it is a highly regulated, high-stakes area that requires specialist financial advice. Okay, so let’s fast forward. We’ve had the property for years, and now it's time to sell. Let’s revisit Capital Gains Tax. CGT is the tax you pay on the profit. It's the selling price minus your 'cost base'. The cost base includes the original purchase price, costs like stamp duty and legal fees, plus any capital improvements you made, less any capital works depreciation you’ve claimed. A key benefit is that if you've held the property for more than 12 months, you are generally entitled to a 50% discount on the capital gain. And what if you lived in the house before you rented it out? This is where the 'market value rule' applies. You are treated as having sold the property to yourself for its market value on the date it was first made available for rent. That value becomes the new cost base. To establish this, you must get a retrospective property valuation from a qualified valuer. It’s a critical step. There is also the handy '6-year rule', which allows you to continue treating your former home as your main residence for up to six years after you move out and rent it out, and still get the full CGT exemption, provided you don’t nominate another property as your main residence. So, as you can hear, there are a lot of moving parts. That’s exactly right. And this is where getting professional advice is essential. At Aevum Accounting, we help our clients navigate this entire lifecycle. We can help forecast the tax implications before you even buy, work with your quantity surveyor, and structure things correctly from day one to plan for Capital Gains Tax in the future. We work with you to make sure your investment is working for you. Absolutely! It’s about turning that money-making machine into a well-oiled, tax-efficient part of your financial future! A fantastic point to end on, Mia. And that brings us to the end of another episode! We hope today's discussion has provided you with valuable insights. Before we go, a quick but important reminder: The information and strategies shared on this podcast are for general informational purposes only and do not constitute specific tax or financial advice. Everyone's situation is unique, and tax laws are complex and constantly evolving. For personalized advice tailored to your specific individual or business needs, we always recommend consulting with a qualified professional. You can connect with our team at Aevum Accounting – visit our website to learn more. Thank you so much for tuning in! If you enjoyed this episode, please consider subscribing, leaving us a review, and sharing it. Until next time, stay savvy, stay proactive, and keep building your financial future! From all of us at Aevum Accounting, goodbye for now!