SMSFs: Investment property tax deduction mistakes to avoid

SMSFs are able to directly invest in residential or commercial property. 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,
  • insurance,
  • 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.
• 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.

• 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.

Investment property expenses your fund can’t claim

The major investment property expenses that 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 of 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, such as invoices and receipts.

2. Understand the difference between property repairs and maintenance and property renovation/improvement

As mentioned earlier, there are different tax deduction implications for these different types of investment property expenses. The ATO conducts routine audits of these types of claims as it’s common for mistakes to be made (i.e. for the total costs of renovations/improvements to be fully claimed in the year that they’re incurred, rather than a claim being correctly made each year for 2.5% of these costs over 40 years).

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 your property for inspections, to collect rent or perform maintenance, it’s important to note that these expenses were an allowable tax deduction prior to the 2017/18 financial year, but it is no longer available.

5. Don’t claim expenses that are paid by tenants

For example, water, electricity or gas charges.

6. Don’t claim costs relating to the sale of the investment property

For example, real estate agent commission and legal fees. 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.

The bottom line

It’s worthwhile to seek independent professional advice when claiming tax deductions on SMSF investment property assets. This will help to ensure your fund’s compliance with relevant tax legislation.

The information contained in this article is general in nature.