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One of the attractions of self-managed super funds (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 2023 real property accounted for more than 14% of total SMSF assets of $876.4 billion. Roughly two thirds of this, or $81.4 billion was in non-residential real estate while $45.2 billion was in residential real estate.
Under the super rules, the property cannot be held in the names of the individual fund members, all fund assets must be held in the name of either:
- The individual trustees ‘as trustees for’ the fund (Dave & Sarah Smith as trustees for the Smith Family Super Fund)
- The corporate trustee ‘as trustee for’ the fund (D & S Pty Ltd as trustee for the Smith Family Super Fund)
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 deductions for investment property expenses against the rental income they generate.
But it’s not open slather. It’s important to understand what your fund can and can’t claim as investment property tax deductions. And be warned – incorrect rental property deductions are regularly targeted in the ATO’s annual compliance hit list.
Check out our full list of guides to SMSFs and property investment.
Investment property expenses your fund can claim
You can claim an immediate deduction for these expenses in the income year you incur them:
- 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
- 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.
This last point is the source of some confusion. 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 generally only be deducted at 2.5% or 4% each year over 40 years or 25 years respectively, 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
- 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.
Capital gains tax (CGT) may apply when you sell your rental property, so keep all records for the period you own it and for five years from the date you sell it. 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 error is for the total cost 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 borrowing expenses if they are more than $100
As mentioned earlier in this article, if borrowing expenses such as loan establishment fees, title search fees and the costs of preparing and filing loan documents are more than $100, they must be claimed over five years.
Don’t claim stamp duty charged by your state or territory government on the property title.
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, 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.
If you make a capital gain on the sale of your investment property, include it in your fund’s tax return for that income year. If you make a capital loss, you can carry forward the loss and deduct it from capital gains in later years.
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 must 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.