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One of the attractions of SMSFs for many people is the ability to invest directly in real property, both residential and commercial, something that is not possible in a public offer super fund.
According to the latest ATO statistics, in June 2020 real property accounted for almost 16% of SMSFs total asset allocation. Roughly two thirds of this, or $73.5 billion was in non-residential real estate while $39.1 billion was in residential real estate.
Under the super rules, the property must be held in the name of the fund, not in the names of individual fund members. If funds are borrowed to fund an SMSF property purchase, they must be obtained under a limited recourse borrowing arrangement.
Well-chosen investment properties can help SMSFs to achieve capital growth over time, as well as rental income from tenants. SMSFs can also reduce their tax payable by claiming investment property expense deductions against the rental income they generate.
However, it’s important to understand what your fund can and can’t claim as investment property tax deductions.
Investment property expenses your fund can claim
The major investment property expenses that your fund can claim are:
- Borrowing charges, such as the interest charged on your loan to buy the property, and many associated loan fees and charges. However, expenses such as loan establishment fees, title search fees and the costs of preparing and submitting mortgage documents must be spread over five years if the amount is over $100.
- Property management fees, such as:
- council rates,
- body corporate fees,
- the cost of advertising for tenants, and
- the cost of using a property management service to manage the property on your behalf.
- Legal expenses associated with the property, such as the costs of having tenant lease documents prepared.
- Depreciation on investment property assets (such as its furniture and appliances). These deductions are usually spread over the cost of the asset’s “estimated useful life”.
- Professional adviser fees, if you pay for the services of a financial planner, mortgage broker or tax agent to help you with your investment property decisions and management.
- Repairs and maintenance costs, such as cleaning, painting, gardening, lawn mowing and pest control expenses.
- Renovations and improvement costs that improve the property’s value, such as installing a new kitchen, bathroom or extension.
However, it’s important to understand that there are different tax implications for deducting renovation and improvement expenses compared to repairs and maintenance costs. Renovation and property improvement costs are treated as capital expenditures and can only be deducted at 2.5% each year over 40 years, unlike repairs and maintenance costs which can be fully deducted in the year they’re incurred.
Investment property expenses your fund can’t claim
The major investment property expenses your fund can’t claim are:
- the purchase price of the property itself,
- conveyancing fees associated with your purchase,
- stamp duty associated with your purchase, and
- building inspection costs associated with your purchase.
However, all these costs are included in your cost base when you sell the property, so they will reduce your potential capital gains tax (CGT) obligation.
Tips to avoid common investment property tax deduction mistakes
1. Make sure you have records for all your tax deduction claims
You must have invoices or receipts to substantiate any of your investment property tax deductions. This is more important than ever in the 2019-20 and 2020-21 financial years due to special arrangements due to COVID-19. Poor record-keeping not only causes delays completing your fund’s accounts, it may make your fund more difficult to audit and increase the risk of penalties for breaching the rules.
2. Understand the difference between property repairs and maintenance and property renovation/improvement
The ATO conducts routine audits of these types of claims as it’s common for mistakes to be made. One common mistake is for the total costs of renovations or improvements to be fully claimed in the year that they’re incurred, rather than a claim being correctly made over a number of years. .
SMSFs can claim an immediate deduction for repairs or maintenance costs to restore items broken, damaged or deteriorating in a property that is currently rented. However, repairs carried out for damages that existed prior to the purchase date of the property can’t be claimed as an immediate deduction, although you may be able to claim them over a number of years as a capital works deduction.
3. Don’t claim the full amount of loan establishment fees, title search fees and the cost of preparing and submitting mortgage documents
As mentioned earlier in this article, if these expenses are more than $100, they must be claimed over five years.
4. Don’t claim the cost of travelling to the investment property
If you need to visit a residential investment property for inspections, to collect rent or perform maintenance, it’s important to note that these expenses have not been allowable tax deductions since 1 July 2017. However, you can claim the cost of travel to a commercial property owned by the fund to collect rents, do repairs, or meet with tenants or letting agents.
5. Don’t claim expenses that are paid by tenants
You can’t claim a tax deduction for water, electricity, gas or other charges paid for by tenants.
6. Don’t claim costs relating to the sale of the investment property
You can’t claim real estate agent commissions, legal fees and other costs associated with the sale of an investment property. However, like purchase costs, these selling expenses can generally be included in your cost base when selling the property, reducing your potential capital gains tax (CGT) obligation.
7. Don’t incorrectly claim loan interest
If your SMSF has entered into a limited recourse borrowing arrangement (LRBA), you can only claim loan interest if the full amount of the loan is used for the purchase of the investment property.
For example, if you used only part of the loan for the investment property and invested the remainder on other fund investments, you would be in breach of the borrowing standards. Instead, any amount not used for the property purchase should be repaid to the lender.
It’s worth seeking independent professional advice when claiming tax deductions on SMSF investment property assets. This will help ensure your fund complies with relevant tax legislation and potentially save you time and money from costly mistakes in the long run.
The information contained in this article is general in nature.