• Expenses deductible over a number of income years

    There are three types of expenses you may incur for your rental property that may be claimed over a number of income years:

    • borrowing expenses
    • amounts for decline in value of depreciating assets
    • capital works deductions.

    Each of these categories is discussed in detail.

    Borrowing expenses

    These are expenses directly incurred in taking out a loan for the property. They include:

    • loan establishment fees
    • title search fees charged by your lender
    • costs for preparing and filing mortgage documents
    • mortgage broker fees
    • stamp duty charged on the mortgage
    • fees for a valuation required for loan approval
    • lender's mortgage insurance billed to the borrower.

    The following are not borrowing expenses:

    • insurance policy premiums on a policy that provides for your loan on the property to be paid out in the event that you die or become disabled or unemployed
    • interest expenses
    • stamp duty charged on the transfer of the property
    • stamp duty incurred to acquire a leasehold interest in property (such as an ACT 99-year Crown lease).

    If your total borrowing expenses are more than $100, the deduction is spread over five years or the term of the loan, whichever is less. If the total deductible borrowing expenses are $100 or less, they are fully deductible in the income year they are incurred.

    If you repay the loan early and in less than five years, you can claim a deduction for the balance of the borrowing expenses in the year of repayment.

    If you obtained the loan part way through the income year, the deduction for the first year will be apportioned according to the number of days in the year that you had the loan.

    Example 20: Apportionment of borrowing expenses

    In order to secure a 20-year loan of $209,000 to purchase a rental property for $170,000 and a private motor vehicle for $39,000, the Hitchmans paid a total of $1,670 in establishment fees, valuation fees and stamp duty on the loan. As the Hitchmans’ borrowing expenses are more than $100, they must be apportioned over five years, or the period of the loan, whichever is the lesser. Also, because the loan was to be used for both income-producing and non-income producing purposes, only the income-producing portion of the borrowing expenses is deductible. As they obtained the loan on 17 July 2015, they would work out the borrowing expense deduction for the first year as follows:

     

    Borrowing expenses

    x

    number of
    relevant days in year
    number of days in the
    5-year period

    =

    maximum amount for the income year

    x

    rental
    property loan
    total borrowings

    =

    deduction for year

    Year 1

    (leap year)

    $1,670

    x

      350 days  
    1,827 days

    =

    $320

    x

    $170,000
    $209,000

    =

    $260

    Their borrowing expense deductions for subsequent years would be worked out as follows:

     

    Borrowing expenses remaining

    x

    number of
    relevant days in year
    number of days in the
    5-year period

    =

    maximum amount for the income year

    x

    rental
    property loan
    total borrowings

    =

    Deduction for year

    Year 2

     

    $1,350

    x

      365 days  
    1,477 days

    =

    $334

    x

    $170,000
    $209,000

    =

    $271

    Year 3

     

    $1,016

    x

      365 days  
    1,112 days

    =

    $333

    x

    $170,000
    $209,000

    =

    $271

    Year 4

    $683

    x

      365 days  
    747 days

    =

    $334

    x

    $170,000
    $209,000

    =

    $271

    Year 5

    (leap year)

    $349

    x

      366 days  
    382 days

    =

    $334

    x

    $170,000
    $209,000

    =

    $272

    Year 6

    $15

    x

      16 days  
    16 days

    =

    $15

    x

    $170,000
    $209,000

    =

    $12

     

    End of example

    Deduction for decline in value of depreciating assets

    When you purchase a rental property, you are treated for tax purposes as having bought a building, plus various separate items of 'plant'. Items of plant are depreciating assets, such as air conditioners, stoves and other items. The purchase price accordingly needs to be allocated between the 'building' and various depreciating assets. For more information about 'plant', see Definitions.

    You can deduct an amount equal to the decline in value for an income year of a depreciating asset that you held for any time during the year. However, your deduction is reduced to the extent your use of the asset is for other than a taxable purpose. If you own a rental property, the taxable purpose will generally be for the purpose of producing rental income.

    Some items found in a rental property are regarded as part of the setting for the rent-producing activity and are not treated as separate assets in their own right. If your depreciating asset is not plant and it is fixed to, or otherwise part of, a building or structural improvement, your expenditure will generally be construction expenditure for capital works and only a capital works deduction may be available.

    For more information, see Capital works deductions.

    How do you work out your deduction?

    You work out your deduction for the decline in value of a depreciating asset using either the prime cost or diminishing value method. Both methods are based on the effective life of the asset. You can work out your deductions using the Depreciation and Capital Allowances Tool (DCAT).

    The diminishing value method assumes that the decline in value each year is a constant proportion of the remaining value and produces a progressively smaller decline over time.

    For depreciating assets you started to hold on or after 10 May 2006, you generally use the following formula for working out decline in value using the diminishing value method:

    base value*

    x

    days held**
    365

    x

             200%        
    asset’s effective life

    * For the income year in which an asset is first used or installed ready for use for any purpose, the base value is the asset’s cost. For a later income year, the base value is the asset’s opening adjustable value plus any amounts included in the asset’s second element of cost for that year.

    ** Can be 366 in a leap year.

    This formula does not apply in some cases, such as if you dispose of and reacquire an asset just so the decline in value of the asset can be worked out using this formula.

    For depreciating assets you started to hold prior to 10 May 2006, the formula for working out decline in value using the diminishing value method is:

    base value*

    x

    days held**
    365

    x

             150%        
    asset’s effective life

    * For the income year in which an asset is first used or installed ready for use for any purpose, the base value is the asset’s cost. For a later income year, the base value is the asset’s opening adjustable value plus any amounts included in the asset’s second element of cost for that year.

    ** Can be 366 in a leap year.An asset’s cost has two elements. The first element of cost is, generally, amounts you are taken to have paid to hold the asset, such as the purchase price. The second element of cost is, generally, the amount you are taken to have paid to bring the asset to its present condition, such as the cost of capital improvements to the asset. If more than one person holds a depreciating asset, each holder works out their deduction for the decline in value of the asset based on their interest in the asset and not on the cost of the asset itself.

    The adjustable value of a depreciating asset is its cost (first and second elements) less its decline in value up to that time. Adjustable value is similar to the concept of undeducted cost used in the former depreciation provisions. The opening adjustable value of an asset for an income year is generally the same as its adjustable value at the end of the previous income year.

    The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life. The formula for working out decline in value using the prime cost method is:

    asset’s cost

    x

    days held**
    365

    x

             100%        
    asset’s effective life

    ** Can be 366 in a leap year

    The formula under the prime cost method may have to be adjusted if the cost, effective life or adjustable value of the asset is modified. For more information, see the Guide to depreciating assets 2016.

    Under the diminishing value method, the decline in value of an asset cannot amount to more than its base value. Under the prime cost method the general rule is value of an asset cannot exceed its opening adjustable value.

    If you use a depreciating asset for other than a taxable purpose (for example, you use the same lawn mower at both your rental property and your private residence) you are allowed only a partial deduction for the asset’s decline in value, based on the percentage of the asset’s total use that was for a taxable purpose.

    Effective life

    Generally, the effective life of a depreciating asset is how long it can be used to produce income:

    • having regard to the wear and tear you reasonably expect from your expected circumstances of use
    • assuming that it will be maintained in reasonably good order and condition
    • having regard to the period within which it is likely to be scrapped, sold for no more than scrap value or abandoned.

    Effective life is expressed in years, including fractions of years. It is not rounded to the nearest whole year.

    For most depreciating assets you can choose to work out the effective life yourself or to use an effective life determined by the Commissioner of Taxation.

    The sort of information you could use to make an estimate of effective life of an asset is listed in the Guide to depreciating assets 2016.

    In making his determination, the Commissioner assumes the depreciating asset is new and has regard to general industry circumstances of use.

    There are various Taxation Rulings made by the Commissioner regarding how to determine the effective life expectancy of depreciating assets:

    Because the Commissioner often reviews the determinations of effective life, the determined effective life may change from the beginning of, or during, an income year. You need to work out which Taxation Ruling, or which schedule accompanying the relevant Taxation Ruling to use for a particular asset’s determined effective life.

    As a general rule, use the ruling or schedule that is in force at the time you:

    • entered into a contract to acquire the depreciating asset
    • otherwise acquired it, or
    • started to construct it.

    Immediate deduction for certain non-business depreciating assets costing $300 or less

    The decline in value of certain depreciating assets costing $300 or less is their cost. This means you get an immediate deduction for the cost of the asset to the extent that you use it to produce assessable income, including rental income, during the income year in which the deduction is available.

    The immediate deduction is available if all of the following tests are met in relation to the asset:

    • it cost $300 or less
    • you used it mainly for the purpose of producing assessable income that was not income from carrying on a business (for example, rental income where your rental activities did not amount to the carrying on of a business)
    • it was not part of a set of assets costing more than $300 that you started to hold in the income year
    • it was not one of a number of identical, or substantially identical, assets that you started to hold in the income year that together cost more than $300.

    If you hold an asset jointly with others and the cost of your interest in the asset is $300 or less, you can claim the immediate deduction even though the total cost of the asset was more than $300; see Partners carrying on a rental property business.

    Example 21: Immediate deduction

    In November 2015, Terry purchased a toaster for his rental property at a cost of $70. He can claim an immediate deduction as he uses the toaster to produce rental income, provided he is not carrying on a business from the rental activity.

    Example 22: No immediate deduction

    Paula is buying a set of four identical dining room chairs costing $90 each for her rental property. She cannot claim an immediate deduction for any of these because they are part of a set of assets, and the total cost is more than $300.

    End of example

    For more information about immediate deductions for depreciating assets costing $300 or less, see the Guide to depreciating assets 2016.

    Low-value pooling

    You can allocate low-cost assets and low-value assets relating to your rental activity to a low-value pool.

    A low-cost asset is a depreciating asset that costs less than $1,000 as at the end of the income year in which you start to use it, or have it installed ready for use, for a taxable purpose.

    A low-value asset is a depreciating asset that is not a low-cost asset but which on 1 July for the current year (1 July 2015) had been written off to less than $1,000 under the diminishing value method.

    If you hold an asset jointly and the cost of your interest in the asset or the opening adjustable value of your interest is less than $1,000, you can allocate your interest in the asset to your low-value pool.

    Once you choose to create a low-value pool and allocate a low-cost asset to it, you must pool all other low-cost assets you start to hold from that time on.. However, this does not apply to low-value assets. You can decide whether to allocate low-value assets to the pool on an asset-by-asset basis.

    Once you have allocated an asset to the pool, it remains in the pool.

    Once an asset is allocated to a low-value pool it is not necessary to work out its adjustable value or decline in value separately. Only one annual calculation for the decline in value for all of the depreciating assets in the pool is required.

    You work out the deduction for the decline in value of depreciating assets in a low-value pool using a diminishing value rate of 37.5%.

    For the income year you allocate a low-cost asset to the pool, you work out its decline in value at a rate of 18.75%, or half the pool rate. Halving the rate recognises that assets may be allocated to the pool throughout the income year and eliminates the need to make separate calculations for each asset based on the date it was allocated to the pool.

    When you allocate an asset to the pool, you must make a reasonable estimate of the percentage that you will use it to produce your assessable income, including rental income, over its effective life. For a low-cost asset, you estimate the effective life when you acquire it. For a low-value asset, you estimate the effective life remaining at the start of the income year in which it was allocated to the pool. This percentage is known as the asset’s taxable use percentage.

    It is this taxable use percentage of the cost or opening adjustable value that is written off through the low-value pool.

    For more information about low-value pooling, including how to treat assets used only partly to produce assessable income, including rental income, and how to treat the disposal of assets from a low-value pool, see the Guide to depreciating assets 2016. You can work out your deductions for assets you allocate to a low-value pool using the Depreciation and Capital Allowances Tool (DCAT)

    If you are an individual who owns or jointly owns a rental property, you claim your low-value pool deduction for rental assets as a ’Low-value pool deduction’ on your tax return, and you do not take this deduction into account in the amount you show at 'Rent’ on your tax return.

    What happens if you no longer hold or use a depreciating asset?

    If you cease to hold or to use a depreciating asset, a balancing adjustment event will occur. If there is a balancing adjustment event, you need to work out a balancing adjustment amount to include in your assessable income or to claim as a deduction.

    A balancing adjustment event occurs for a depreciating asset if:

    • you stop holding it, for example, if the asset is sold, lost or destroyed
    • you stop using it and expect never to use it again
    • you stop having it installed ready for use and you expect never to install it ready for use again
    • you have not used it and decide never to use it, or
    • a change occurs in the holding or interests in an asset which was or is to become a partnership asset.

    You work out the balancing adjustment amount by comparing the asset’s termination value (such as the proceeds from the sale of the asset) and its adjustable value at the time of the balancing adjustment event. If the termination value is greater than the adjustable value, you include the excess in your assessable income. If you are an individual who owns or has co-ownership of a rental property, you show the assessable amount as Other income on your tax return and do not take it into account in the amount you show at Rent.

    If the termination value is less than the adjustable value, you can deduct the difference.

    For more information about balancing adjustments, see the Guide to depreciating assets 2016.

    If a balancing adjustment event happens to a depreciating asset that you used at some time other than for income-producing purposes (for example, privately) then a capital gain or capital loss might arise to the extent that you so used the asset. You can work out balancing adjustments using the Depreciation and Capital Allowances Tool (DCAT) available on ato.gov.au

    For more information about capital gains tax and depreciating assets see the Guide to depreciating assets 2016.

    Purchase and valuation of second-hand assets

    If you purchase a second-hand asset you can generally claim a deduction based on the cost of the asset to you.

    Where you pay an amount for a depreciating asset and something else, only that part that is reasonably attributable to the depreciating asset is treated as being paid for.

    Where you purchase a rental property from an unrelated party, one objective means of establishing your cost of depreciating assets acquired with the property is to have their value, as agreed between the contracting parties, specified in the sale agreement. If the sale agreement for your property does not specify separate values for the depreciating assets, you will need to work out a reasonable cost for the assets to determine your claim for depreciation.

    You can do this yourself or you may wish to use a qualified valuer. Any valuation methodology used to work out the cost of the depreciating assets must be able to demonstrate a reasonable basis for that value having regard to the market value of the asset and the overall cost of the property.

    Example 23: Valuation of second-hand assets

    The Sullivans purchase a rental property with a 6 year old gas hot water system. It is reasonable to apply the Commissioner’s effective life determination of 12 years (for gas hot water systems) and treat the asset as having 6 years remaining effective life. If the system cost $1,200 new, it is reasonable to estimate the value of the hot water system was $600 at the time of purchasing the rental property. Therefore, in working out how much they can claim for the decline in value of the hot water system, the Sullivans use $600 as its cost.

    End of example

    Apportionment of values between various assets affects the cost base of the property which is subject to capital gains tax. Amounts allocated to the cost of depreciating assets on the purchase of the rental property are subtracted from the purchase price, in order to arrive at the CGT cost base of the rental property.

    Working out your deductions for decline in value of depreciating assets

    Following are two examples of working out decline in value deductions. The Guide to depreciating assets 2016 contains two worksheets (Worksheet 1: Depreciating assets and Worksheet 2: Low-value pool) that you can use to work out your deductions for decline in value of depreciating assets. Alternatively, you can work out your deductions using the Depreciation and Capital Allowances Tool (DCAT) available at ato.gov.au

    Example 24: Working out decline in value deductions

    In this example, the Hitchmans bought a property part way through the year, on 20 July 2015. In the purchase contract, depreciating assets sold with the property were assigned separate values that represented their market values at the time. The Hitchmans could use the amounts shown in the contract to work out the cost of their individual interests in the assets. They can each claim deductions for decline in value for 347 days of the 2015–16 income year. If the Hitchmans use the assets wholly to produce rental income, the deduction for each asset using the diminishing value method is worked out as shown below:

    Description

    Cost of the interest in the asset

    Base value

    No. of days held, divided by 365

    200% divided by effective life

    (yrs)

    Deduction for decline in value

    Adjustable value at end of 2015-16 income year

    Furniture

    $2,000

    $2,000

    347
    365

    200%
    13 1/3

    $285

    $1,715

    Carpets

    $1,200

    $1,200

    347
    365

    200%
    10

    $228

    $972

    Curtains

    $1,000

    $1,000

    347
    365

    200%
    6

    $317

    $683*

    Totals

    $4,200

    $4,200

     

     

    $830

    $3,370

    * As the adjustable values of the curtains and the carpets at the end of the 2015–16 income year are less than $1,000, either or both of the Hitchmans can choose to transfer their interest in the curtains and the carpets to their low-value pool for the following income year (2016–17).

    End of example

     

    Example 25: Decline in value deductions, low-value pool

    In the 2015–16 income year the Hitchmans’ daughter, Leonie, who owns a rental property in Adelaide, allocated to a low-value pool some depreciating assets she acquired in that year. The low-value pool already comprised various low-value assets. Leonie expects to use the assets solely to produce rental income.

     

    Taxable use percentage of cost or opening adjustable value

    Low-value pool rate

    Deduction for decline in value in 2015–16

    Low-value assets:

    Various

    $1,679

    37.5%

    $630

    Low-cost assets:

    Television set
    (purchased 11/11/2015)

    $747

     

     

    Gas heater
    (purchased 28/2/2016)

    $303

     

     

    Total low-cost assets

    $1,050

    18.75%

    $197

    Total deduction for decline in value for year ended 30 June 2016

     

     

    $827

    Closing pool value at 30 June 2016

    Low-value assets: $1,679 –$630

    =

    $1,049

    Low-cost assets: $1,050 – $197

    =

    $853

     

    =

    $1,902

     

    End of example

    Capital works deductions

    You can deduct certain kinds of construction expenditure. In the case of residential rental properties, the deductions would generally be spread over a period of 25 or 40 years. These are referred to as capital works deductions. Your total capital works deductions cannot exceed the construction expenditure. No deduction is available until the construction is complete.

    Deductions based on construction expenditure apply to capital works such as:

    • a building or an extension, for example, adding a room, garage, patio or pergola
    • alterations, such as removing or adding an internal wall
    • structural improvements to the property, for example, adding a gazebo, carport, sealed driveway, retaining wall or fence.

    You can only claim deductions for the period during the year that the property is rented or is available for rent.

    Where the rental property is destroyed, for example by fire, and results in a total loss of the asset, you can deduct an amount in the income year in which the capital works are destroyed for all of your construction expenditure that has not yet been deducted. However, you must reduce this deduction by any insurance and salvage receipts.

    If however, using the same example above, during an income year the building is affected by fire and the building cannot be rented or made available for rent but it is expected to be made available for rent again, then the owners cannot claim a deduction for capital works for the number of days that the building is not available for rent.

    If you can claim capital works deductions, the construction expenditure on which those deductions are based cannot be taken into account in working out any other types of deductions you claim, such as deductions for decline in value of depreciating assets.

    Amount of deduction

    The amount of the deduction you can claim depends on the type of construction and the date construction started.

    Table 1 below shows you the types of rental property construction that qualify. If the type of construction you own (or own jointly) does not appear next to the relevant ‘date construction started’ in the Table, you cannot claim a deduction. If the type of construction qualifies, Table 2 shows the rate of deduction available.

    Table 1

    Date construction started

    Type of construction for which deduction can be claimed

    Before 22 August 1979

    None

    22 August 1979 to
    19 July 1982

    Certain buildings* intended to be used on completion to provide short-term accommodation to travellers**

    20 July 1982 to
    17 July 1985

    Certain buildings* intended to be used on completion to provide short-term accommodation to travellers**

    Building intended to be used on completion for non-residential purposes (for example, a shop or office)

    18 July 1985 to
    26 February 1992

    Any building intended to be used on completion for residential purposes or to produce income

    27 February 1992 to
    18 August 1992

    Certain buildings* intended to be used on completion to provide short-term accommodation to travellers**

    Any other building intended to be used on completion for residential purposes or to produce income

    Structural improvements intended to be used on completion for residential purposes or to produce income

    19 August 1992 to
    30 June 1997

    Certain buildings* intended to be used on completion to provide short-term accommodation to travellers**

    Any other building intended to be used on completion for residential purposes or to produce income

    Structural improvements intended to be used on completion for residential purposes or to produce income

    Environment protection earthworks** intended to be used on completion for residential purposes or to produce income

    After 30 June 1997

    Any capital works used to produce income (even if, on completion, it was not intended that they be used for that purpose)

    *‘Certain buildings’ are apartment buildings in which you own or lease at least 10 apartments, units or flats; or a hotel, motel or guest house that has at least 10 bedrooms.

    **For more information, phone 13 28 66.

    Table 2

    Date construction started

    Rate of deduction per income year

    Before 22 August 1979

    nil

    22 August 1979 to 21 August 1984

    2.5%

    22 August 1984 to 15 September 1987

    4%

    After 15 September 1987

    2.5%

    Where construction of a building to provide short-term accommodation for travellers commenced after 26 February 1992, the rate of deduction was increased to 4%.

    For apartment buildings, the 4% rate applies to apartments, units or flats only if you own or lease 10 or more of them in the building.

    The deduction can be claimed for 25 years from the date construction was completed in the case of a 4% deduction, and for 40 years from the date construction was completed in the case of a 2.5% deduction. If the construction was completed part of the way through the income year, you can claim a pro-rata deduction for that part.

    Construction expenditure that can be claimed

    Construction expenditure is the actual cost of constructing the building or extension. A deduction is allowed for expenditure incurred in the construction of a building if you contract a builder to construct the building on your land. This includes the component of your payments that represents the profit made by individual tradespeople, builders and architects. If you are an owner/builder, the value of your contributions to the works, for example, your labour and expertise, and any notional profit element do not form part of the construction expenditure.

    If you purchase your property from a speculative builder, you cannot claim the component of your payment that represents the builder’s profit margin as a capital works deduction.

    Some costs that you may include in construction expenditure are:

    • preliminary expenses such as architects’ fees, engineering fees and the cost of foundation excavations
    • payments to carpenters, bricklayers and other tradespeople for construction of the building
    • payments for the construction of retaining walls, fences and in-ground swimming pools.

    Construction expenditure that cannot be claimed

    Some costs that are not included in construction expenditure are:

    • the cost of the land on which the rental property is built
    • expenditure on clearing the land prior to construction
    • earthworks that are permanent, can be economically maintained and are not integral to the installation or construction of a structure
    • expenditure on landscaping.

    Changes in building ownership

    Where ownership of the building changes, the right to claim any undeducted construction expenditure for capital works passes to the new owner. A new owner should confirm that the building was constructed during one of the appropriate periods outlined in table 1. To be able to claim the deduction, the new owner must continue to use the building to produce income.

    If the previous owner was allowed capital works deductions, and the capital works started after 26 February 1992, they are required to give you as the new owner information that will enable you to calculate those deductions going forward. Where the property was not previously used to produce assessable income, the owner disposing of the property does not need to provide the purchaser with that information. In this situation the purchaser may obtain an estimate from a professional. For more information, see Estimating construction costs.

    For more information about providing a notice or certificate, see Subsection 262A(4AJA) of Income Tax Assessment Act 1936.

    Estimating construction costs

    Where a new owner is unable to determine precisely the construction expenditure associated with a building, an estimate provided by an appropriately qualified person may be used. Appropriately qualified people include:

    • a clerk of works, such as a project organiser for major building projects
    • a supervising architect who approves payments at stages of projects
    • a builder who is experienced in estimating construction costs of similar building projects
    • a quantity surveyor.

    Unless they are otherwise qualified, valuers, real estate agents, accountants and solicitors generally have neither the relevant qualifications nor the experience to make such an estimate.

    Example 26: Estimating capital works deductions

    The Perth property acquired by the Hitchmans on 20 July 2015 was constructed in August 1991. At the time they acquired the property it also contained the following structural improvements.

    Item

    Construction date

    Retaining wall

    September 1991

    Concrete driveway

    January 1992

    In-ground swimming pool

    July 1992

    Protective fencing around the pool

    August 1992

    Timber decking around the pool

    September 1992

    In a letter to the Hitchmans, a supervising architect estimated the construction cost of the rental property for capital works deduction purposes at $115,800. This includes the cost of the house, the in-ground swimming pool, the protective fencing and the timber decking. Although the retaining wall and the concrete driveway are structural improvements, they were constructed before 27 February 1992 (In table 1, structural improvements qualified for deduction from 27 February 1992). Therefore, they do not form part of the construction cost for the purposes of the capital works deduction and were not included in the $115,800 estimate.

    The Hitchmans can claim a capital works deduction of 2.5% of the construction costs per year. As they did not acquire the property until 20 July 2015, they can claim the deduction for the 347 days from 20 July 2015 to 30 June 2016. The maximum deduction for 2015–16 would be worked out as follows:

    Construction cost

    X

    rate

    X

    portion of year

    =

    deductible amount

    $115,800

    X

    2.5%

    X

    347
    365

    =

    $2,752

     

    End of example

    The cost of obtaining an appropriately qualified person’s estimate of construction costs of a rental property is deductible in the income year it is incurred. You make your claim for the expense, or your share of the expense if you jointly incurred it, at Cost of managing tax affairs on your tax return.

    For more information about construction expenditure and capital works deductions, see:

    Cost base adjustments for capital works deductions

    In working out a capital gain or capital loss from a rental property, the cost base and reduced cost base of the property may need to be reduced to the extent that it includes construction expenditure for which you have claimed or can claim a capital works deduction.

    Cost base

    You must exclude from the cost base of a CGT asset (including a building, structure or other capital improvement to land that is treated as a separate asset for CGT purposes*) the amount of capital works deductions you have claimed or can claim in respect of the asset if:

    • you acquired the asset after 7.30pm (by legal time in the ACT) on 13 May 1997, or
    • you acquired the asset before that time and the expenditure that gave rise to the capital works deductions was incurred after 30 June 1999.

    For information on when a building, structure or other capital improvement to land is treated as a CGT asset separate from the land, see chapter 1 and the section Major capital improvements to a dwelling acquired before 20 September 1985 in the Guide to capital gains tax 2016.

    Reduced cost base

    The amount of the capital works deductions you have claimed or can claim for expenditure you incurred in respect of an asset is excluded from the reduced cost base.

    For more information about whether you can claim certain capital works deductions, see:

    • Taxation Determination TD 2005/47 – Income tax: what do the words ‘can deduct’ mean in the context of those provisions in Division 110 of the Income Tax Assessment Act 1997 which reduce the cost base or reduced cost base of a CGT asset by amounts you ‘have deducted or can deduct’, and is there a fixed point in time when this must be determined? and
    • Law Administration Practice Statement (General Administration) PS LA 2006/1 (GA) – Calculating cost base of CGT asset where there is insufficient information to determine any Division 43 capital works deduction

    Example 27: Capital works deduction

    Zoran acquired a rental property on 1 July 1998 for $200,000. Before disposing of the property on 30 June 2016, he had claimed $10,000 in capital works deductions.

    At the time of disposal, the cost base of the property was $210,250. Zoran must reduce the cost base of the property by $10,000 to $200,250.

    End of example

    Limited recourse debt arrangements

    If expenditure on a depreciating asset (which includes construction expenditure) is financed or refinanced wholly or partly by limited recourse debt (including a notional loan under certain hire purchase or instalment sale agreements of goods), you must include excessive deductions for the capital allowances as assessable income. This will occur where the limited recourse debt arrangement terminates but has not been paid in full by the debtor. Because the debt has not been paid in full, the capital allowance deductions, including capital works deductions, allowed for the expenditure exceed the deductions that would be allowable if the unpaid amount of the debt was not counted as capital expenditure of the debtor. Special rules apply for working out whether the debt has been fully paid.

    If you are not sure what constitutes a limited recourse debt or how to work out your adjustment to assessable income, contact your recognised tax adviser.

    Prepaid expenses

    If you prepay a rental property expense, such as insurance or interest on money borrowed, that covers a period of 12 months or less and the period ends on or before 30 June 2017, you can claim an immediate deduction. A prepayment that does not meet these criteria and is $1,000 or more may have to be spread over two or more years. This is also the case if you carry on your rental activity as a small business entity and have not chosen to deduct certain prepaid business expenses immediately.

    For more information, see Deductions for prepaid expenses

    Keeping records

    General

    You should keep records of both income and expenses relating to your rental property.

    Records of rental expenses must be in English, or be readily translatable into English, and include the:

    • name of the supplier
    • amount of the expense
    • nature of the goods or services
    • date the expense was incurred
    • date of the document.

    If a document does not show the payment date you can use independent evidence, such as a bank statement, to show the date the expense was incurred.

    You must keep records of your rental income and expenses for five years from 31 October or, if you lodge later, for five years from the date you lodge your tax return. If at the end of this period you are in a dispute with us that relates to your rental property, you must keep the relevant records until the dispute is resolved.

    Do not send these records in with your tax return. Keep them in case we ask to see them.

    The following list provides some examples of records you should keep to make it easier to complete your tax return:

    • loan documents
    • receipts for expenses, including repairs, maintenance, insurance and purchases of depreciable assets
    • land tax assessments
    • credit card records
    • tenant leases
    • bank statements
    • rent records from managing agents.
      Last modified: 26 May 2016QC 48221