Show download pdf controls
  • Rental expenses

    Attention

    Warning:

    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

    End of attention

    You can claim a deduction for certain expenses you incur for the period your property is rented or is available for rent. However, you cannot claim expenses of a capital nature or private nature - although you may be able to claim decline in value deductions or capital works deductions for certain capital expenditure or include certain capital costs in the cost base of the property for capital gains tax (CGT) purposes.  

    Types of rental expenses

    There are three categories of rental expenses - those for which you:

    • cannot claim deductions
    • can claim an immediate deduction in the income year you incur the expense
    • can claim deductions over a number of income years.

    Each of these categories is discussed in detail.

    Apportionment of rental expenses

    There may be situations where not all your expenses are deductible and you need to work out the deductible portion. To do this you subtract any non-deductible expenses from the total amount you have for each category of expense; what remains is your deductible expense.

    You will need to apportion your expenses if any of the following apply to you:

    • your property is available for rent for only part of the year
    • only part of your property is used to earn rent
    • you rent your property at non-commercial rates.
    Property available for part-year rental

    If you use your property for both private and assessable income-producing purposes, you cannot claim a deduction for the portion of any expenditure that relates to your private use. Examples of properties you may use for both private and income-producing purposes are holiday homes and time-share units. In cases such as these you cannot claim a deduction for any expenditure incurred for those periods when the home or unit was used by you, your relatives or your friends for private purposes.

    In some circumstances, it may be easy to decide which expenditure is private in nature. For example, council rates paid for a full year would need to be apportioned on a time basis according to private use and assessable income-producing use where a property is used for both purposes during the year.

    In other circumstances, where you are not able to specifically identify the direct cost, your expenses will need to be apportioned on a reasonable basis.

    Example 5: Apportionment of expenses where property is rented for part of the year 

    Mr Hitchman's brother, Dave, owns a property in Tasmania. He rents out his property during the period 1 November 2008 to 30 March 2009 - a total of 150 days. He lives alone in the house for the rest of the year. The council rates are $1,000 per year. He apportions the council rates on the basis of time rented.

    Rental expense × portion of year = deductible amount

    He can claim a deduction against his rental income of:

    $1,000 × (150 ÷ 365) = $411

    End of example

    If he had any other expenses, such as telephone expenses, these too may need to be apportioned on a reasonable basis - which may be different from the basis used in the above example.

    Only part of your property is used to earn rent

    If only part of your property is used to earn rent, you can claim only that part of the expenses that relates to the rental income. As a general guide, apportionment should be made on a floor-area basis - that is, by reference to the floor area of that part of the residence solely occupied by the tenant, together with a reasonable figure for tenant access to the general living areas, including garage and outdoor areas if applicable.

    Example 6: Renting out part of a residential property 

    Michael's private residence includes a self-contained flat. The floor area of the flat is one-third of the area of the residence.

    Michael rented out the flat for six months in the year at $100 per week. During the rest of the year, his niece, Fiona, lived in the flat rent free.

    The annual mortgage interest, building insurance, rates and taxes for the whole property amounted to $9,000. Using the floor-area basis for apportioning these expenses, one-third - that is $3,000 - applies to the flat. However, as Michael used the flat to produce assessable income for only half of the year, he can claim a deduction for only $1,500 - half of $3,000.

    Assuming there were no other expenses, Michael would calculate the net rent from his property as:

    Gross rent
    (26 weeks × $100)

    $2,600

    Less expenses
    ($3,000 × 50%)

    $1,500

    Net rent

    $1,100

     

    End of example

    For more information about the apportionment of expenses, see Taxation Ruling IT 2167 - Income tax: rental properties - non-economic rental, holiday home, share of residence, etc. cases, family trust cases and Taxation Ruling TR 97/23 - Income tax: deductions for repairs.

    Non-commercial rental

    If you let a property - or part of a property - at less than normal commercial rates, this may limit the amount of deductions you can claim.

    Example 7: Renting to a family member 

    Mr and Mrs Hitchman were charging their previous Queensland tenants the normal commercial rate of rent - $180 per week. They allowed their son, Tim, to live in the property at a nominal rent of $40 per week. Tim lived in the property for four weeks. When he moved out, the Hitchmans advertised for tenants.

    Although Tim was paying rent to the Hitchmans, the arrangement was not based on normal commercial rates. As a result, the Hitchmans cannot claim a deduction for the total rental property expenses for the period Tim was living in the property. Generally, a deduction can be claimed for rental property expenses up to the amount of rental income received from this type of non-commercial arrangement.

    Assuming that during the four weeks of Tim's residence the Hitchmans incurred rental expenses of more than $160, these deductions would be limited to $160 in total - that is, $40 × 4 weeks.

    If Tim had been living in the house rent free, the Hitchmans would not have been able to claim any deductions for the time he was living in the property.

    End of example

    For more information about non-commercial rental arrangements, see Taxation Ruling IT 2167.

    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 2010, 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 (NAT 4170).

    Expenses for which you cannot claim deductions

    Expenses for which you are not able to claim deductions include:

    • acquisition and disposal costs of the property
    • expenses not actually incurred by you, such as water or electricity charges borne by your tenants
    • expenses that are not related to the rental of a property, such as expenses connected to your own use of a holiday home that you rent out for part of the year.

    Acquisition and disposal costs

    You cannot claim a deduction for the costs of acquiring or disposing of your rental property. Examples of expenses of this kind include the purchase cost of the property, conveyancing costs, advertising expenses and stamp duty on the transfer of the property (but not stamp duty on a lease of property - see Lease document expenses). However, these costs may form part of the cost base of the property for CGT purposes. See also Capital gains tax.

    Example 8: Acquisition costs

    The Hitchmans purchased a rental property for $170,000 in July 2008. They also paid surveyor's fees of $350 and stamp duty of $750 on the transfer of the property. None of these expenses is deductible against the Hitchmans' rental income. However, in addition to the $170,000 purchase price, the incidental costs of $350 and $750 - totalling $1,100 - are included in the cost base and reduced cost base of the property.

    This means that when the Hitchmans dispose of the property, $171,100 ($170,000 + $1,100) will be included in the cost base or reduced cost base for the purposes of determining the amount of any capital gain or capital loss.

    End of example

    For more information, see the Guide to capital gains tax (NAT 4151).

    Expenses for which you can claim an immediate deduction

    Expenses for which you may be entitled to an immediate deduction in the income year you incur the expense include:

    You can claim a deduction for these expenses only if you actually incur them and they are not paid by the tenant.

    Body corporate fees and charges

    You may be able to claim a deduction for body corporate fees and charges you incur for your rental property.

    Body corporate fees and charges may be incurred to cover the cost of day-to-day administration and maintenance or they may be applied to a special purpose fund.

    Payments you make to body corporate administration funds and general purpose sinking funds are considered to be payments for the provision of services by the body corporate and you can claim a deduction for these levies at the time you incur them. However, if the body corporate requires you to make payments to a special purpose fund to pay for particular capital expenditure, these levies are not deductible. Similarly, if the body corporate levies a special contribution for major capital expenses to be paid out of the general purpose sinking fund, you will not be entitled to a deduction for this special contribution amount. This is because payments to cover the cost of capital improvements or repairs of a capital nature are not deductible - see Repairs and maintenance and Taxation Ruling TR 97/23. You may be able to claim a capital works deduction for the cost of capital improvements or repairs of a capital nature once the cost has been charged to either the special purpose fund or, if a special contribution has been levied, the general purpose sinking fund - see Capital works deductions.

    A general purpose sinking fund is one established to cover a variety of unspecified expenses (some of which may be capital expenses) that are likely to be incurred by the body corporate in maintaining the common property (for example, painting of the common property, repairing or replacing fixtures and fittings of the common property). A special purpose fund is one that is established to cover a specified, generally significant, expense which is not covered by ongoing contributions to a general purpose sinking fund. Most special purpose funds are established to cover costs of capital improvement to the common property.

    If the body corporate fees and charges you incur are for things like the maintenance of gardens, deductible repairs and building insurance, you cannot also claim deductions for these as part of other expenses. For example, you cannot claim a separate deduction for garden maintenance if that expense is already included in body corporate fees and charges.

    Interest on loans

    If you take out a loan to purchase a rental property, you can claim the interest charged on that loan, or a portion of the interest, as a deduction. However, the property must be rented, or available for rental, in the income year for which you claim a deduction. If you start to use the property for private purposes, you cannot claim any interest expenses you incur after you start using the property for private purposes.

    While the property is rented, or available for rent, you may also claim interest charged on loans taken out:

    • to purchase depreciating assets
    • for repairs
    • for renovations.

    Similarly, if you take out a loan to purchase land on which to build a rental property or to finance renovations to a property you intend to rent out, the interest on the loan will be deductible from the time you took the loan out. However, if your intention changes - for example, you decide to use the property for private purposes and you no longer use it to produce rent or other income - you cannot claim the interest after your intention changes.

    Banks and other lending institutions offer a range of financial products which can be used to acquire a rental property. Many of these products permit flexible repayment and redraw facilities. As a consequence, a loan might be obtained to purchase both a rental property and, for example, a private car. In cases of this type, the interest on the loan must be apportioned into deductible and non-deductible parts according to the amounts borrowed for the rental property and for private purposes. A simple example of the necessary calculation for apportionment of interest is shown at Example 9.

    If you have a loan account that has a fluctuating balance due to a variety of deposits and withdrawals and it is used for both private purposes and rental property purposes, you must keep accurate records to enable you to calculate the interest that applies to the rental property portion of the loan; that is, you must separate the interest that relates to the rental property from any interest that relates to the private use of the funds.

    If you have difficulty calculating your deduction for interest, contact your recognised tax adviser or us.

    Some rental property owners borrow money to buy a new home and then rent out their previous home. If there is an outstanding loan on the old home and the property is used to produce income, the interest outstanding on the loan, or part of the interest, will be deductible. However, an interest deduction cannot be claimed on the loan used to buy the new home because it is not used to produce income. This is the case whether or not the loan for the new home is secured against the former home.

    Example 9: Apportionment of interest

    The Hitchmans decide to use their bank's 'Mortgage breaker' account to take out a loan of $209,000 from which $170,000 is to be used to buy a rental property and $39,000 is to be used to purchase a private car. They will need to work out each year how much of their interest payments is tax deductible. The following whole-year example illustrates an appropriate method that could be used to calculate the proportion of interest that is deductible. The example assumes an interest rate of 6.75% per annum on the loan and that the property is rented from 1 July:

    Interest for year 1 = $209,000 × 6.75% = $14,108

    Apportionment of interest payment related to rental property:

    Total interest expense × (rental property loan ÷ total borrowings) = deductible interest

    $14,108 × ($170,000 ÷ $209,000) = $11,475

    End of example

    If you prepay interest it may not be deductible all at once - see Prepaid expenses.

    Thin capitalisation

    If you are an Australian resident and you (or any associate entities) have certain overseas interests or if you are a foreign resident, thin capitalisation rules may apply if your debt deductions - such as interest (combined with those of your associate entities) - for 2008–09 are more than $250,000. See the Thin capitalisation, complete the Thin capitalisation schedule & instructions 2009 and, if required under the thin capitalisation rules, only claim a reduced amount.

    For more information about the deductibility of interest, see:

    • Taxation Ruling TR 2004/4 - Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities
    • Taxation Ruling TR 2000/2 - Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities
    • Taxation Ruling TR 98/22 - Income tax: the taxation consequences for taxpayers entering into certain linked or split loan facilities
    • Taxation Ruling TR 95/25 - Income tax: deductions for interest under subsection 51-1 of the Income Tax Assessment Act 1936 following FC of T v. Roberts, FC of T v. Smith
    • Taxation Ruling TR 93/7 - Income tax: whether penalty interest payments are deductible
    • Taxation Determination TD 1999/42 - Income tax: do the principles set out in Taxation Ruling TR 98/22 apply to line of credit facilities?

    If you need help to calculate your interest deduction, contact your recognised tax adviser or us.

    Lease document expenses

    Your share of the costs of preparing and registering a lease and the cost of stamp duty on a lease are deductible to the extent that you have used, or will use, the property to produce income. This includes any such costs associated with an assignment or surrender of a lease.

    For example, freehold title cannot be obtained for properties in the Australian Capital Territory (ACT). They are commonly acquired under a 99-year crown lease. Therefore, stamp duty, preparation and registration costs you incur on the lease of an ACT property are deductible to the extent that you use the property as a rental property.

    Legal expenses

    Some legal expenses incurred in producing your rental income are deductible - for example, the cost of evicting a non-paying tenant.

    Most legal expenses, however, are of a capital nature and are therefore not deductible. These include costs of:

    • purchasing or selling your property
    • resisting land resumption
    • defending your title to the property.

    Non-deductible legal expenses which are capital in nature may, however, form part of the cost base of your property for capital gains tax purposes. For more information, see the Guide to capital gains tax 2008–09. See also Capital gains tax.

    Example 10: Deductible legal expenses

    In September 2008, the Hitchmans' tenants moved out, owing four weeks rent. The Hitchmans retained the bond money and took the tenants to court to terminate the lease and recover the balance of the rent. The legal expenses they incurred doing this are fully deductible. The Hitchmans were seeking to recover assessable rental income, and they wished to continue earning income from the property. The Hitchmans must include the retained bond money and the recovered rent in their assessable income in the year of receipt.

    End of example
    Mortgage discharge expenses

    Mortgage discharge expenses are the costs involved in discharging a mortgage other than payments of principal and interest. These costs are deductible in the year they are incurred to the extent that you took out the mortgage as security for the repayment of money you borrowed to use to produce assessable income.

    For example, if you used a property to produce rental income for half the time you held it and as a holiday home for the other half of the time, 50% of the costs of discharging the mortgage are deductible.

    Mortgage discharge expenses may also include penalty interest payments. Penalty interest payments are amounts paid to a lender, such as a bank, to agree to accept early repayment of a loan - including a loan on a rental property. The amounts are commonly calculated by reference to the number of months that interest payments would have been made had the premature repayment not been made.

    Penalty interest payments on a loan relating to a rental property are deductible if:

    • the loan moneys borrowed are secured by a mortgage over the property and the payment effects the discharge of the mortgage, or
    • payment is made in order to rid the taxpayer of a recurring obligation to pay interest on the loan.
    Repairs and maintenance

    Expenditure for repairs you make to the property may be deductible. However, the repairs must relate directly to wear and tear or other damage that occurred as a result of your renting out the property.

    Repairs generally involve a replacement or renewal of a worn out or broken part - for example, replacing some guttering damaged in a storm or part of a fence that was damaged by a falling tree branch.

    However, the following expenses are capital, or of a capital nature, and are not deductible:

    • replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or refrigerator)
    • improvements, renovations, extensions and alterations, and
    • initial repairs - for example, in remedying defects, damage or deterioration that existed at the date you acquired the property.

    You may be able to claim capital works deductions for these expenses - for more information, see Capital works deductions. Expenses of a capital nature may form part of the cost base of the property for capital gains tax purposes - but not generally to the extent that capital works deductions have been or can be claimed for them. For more information, see the Guide to capital gains tax. See also Cost base adjustments for capital works deductions.

    Example 11: Repairs prior to renting out the property 

    The Hitchmans needed to do some repairs to their newly acquired rental property before the first tenants moved in. They paid an interior decorator to repaint dirty walls, replace broken light fittings and repair doors on two bedrooms. They also discovered white ants in some of the floorboards. This required white ant treatment and replacement of some of the boards.

    These expenses were incurred to make the property suitable for rental and did not arise from the Hitchmans' use of the property to generate assessable rental income. The expenses are capital in nature and the Hitchmans are not able to claim a deduction for these expenses.

    End of example

    Repairs to a rental property will generally be deductible if:

    • the property continues to be rented on an ongoing basis, or
    • the property remains available for rental but there is a short period when the property is unoccupied - for example, where unseasonable weather causes cancellations of bookings or advertising is unsuccessful in attracting tenants.

    If you no longer rent the property, the cost of repairs may still be deductible provided:

    • the need for the repairs is related to the period in which the property was used by you to produce income, and
    • the property was income-producing during the income year in which you incurred the cost of repairs.

    Example 12: Repairs when the property is no longer rented out 

    After the last tenants moved out in September 2008, the Hitchmans discovered that the stove did not work, kitchen tiles were cracked and the toilet window was broken. They also discovered a hole in a bedroom wall that had been covered with a poster. In October 2008 the Hitchmans paid for this damage to be repaired so they could sell the property.

    As the tenants were no longer in the property, the Hitchmans were not using the property to produce assessable income. However, they could still claim a deduction for repairs to the property because the repairs related to the period when their tenants were living in the property and the repairs were completed before the end of the income year in which the property ceased to be used to produce income.

    End of example

    Examples of repairs for which you can claim deductions are:

    • replacing broken windows
    • maintaining plumbing
    • repairing electrical appliances.

    Examples of improvements for which you cannot claim deductions are:

    Travel and car expenses

    If you travel to inspect or maintain your property or collect the rent, you may be able to claim the costs of travelling as a deduction. You are allowed a full deduction where the sole purpose of the trip relates to the rental property. However, in other circumstances you may not be able to claim a deduction or you may be entitled to only a partial deduction.

    If you fly to inspect your rental property, stay overnight, and return home on the following day, all of the airfare and accommodation expenses would generally be allowed as a deduction provided the sole purpose of your trip was to inspect your rental property.

    Example 13: Travel and vehicle expenses

    Although their local rental property was managed by a property agent, Mr Hitchman decided to inspect the property three months after the tenants moved in. During the income year Mr Hitchman also made a number of visits to the property in order to carry out minor repairs. Mr Hitchman travelled 162 kilometres during the course of these visits. On the basis of a cents-per-kilometre rate of 74 cents for his 2.6 litre car (Note) Mr Hitchman can claim the following deduction:

    Distance travelled × rate per km = deductible amount

    162 km × 74 cents per km = $119.88

    On his way to golf each Saturday, Mr Hitchman drove past the property to 'keep an eye on things'. These motor vehicle expenses are not deductible as they are incidental to the private purpose of the journey.

    Note: See TaxPack 2009 or visit ato.gov.au for the appropriate rates.

    End of example
    Apportionment of travel expenses

    Where travel related to your rental property is combined with a holiday or other private activities, you may need to apportion the expenses.

    If you travel to inspect your rental property and combine this with a holiday, you need to take into account the reasons for your trip. If the main purpose of your trip is to have a holiday and the inspection of the property is incidental to that main purpose, you cannot claim a deduction for the cost of the travel. However, you may be able to claim local expenses directly related to the property inspection and a proportion of accommodation expenses.

    Example 14: Apportionment of travel expenses

    The Hitchmans also owned another rental property in a resort town on the north coast of Queensland. They spent $1,000 on airfares and $1,500 on accommodation when they travelled from their home in Perth to the resort town, mainly for the purpose of holidaying, but also to inspect the property. They also spent $50 on taxi fares for the return trip from the hotel to the rental property. The Hitchmans spent one day on matters relating to the rental property and nine days swimming and sightseeing.

    No deduction can be claimed for any part of the $1,000 airfares.

    The Hitchmans can claim a deduction for the $50 taxi fare.

    A deduction for 10% of the accommodation expenses (10% of $1,500 = $150) would be considered reasonable in the circumstances. The total travel expenses the Hitchmans can claim are therefore $200 ($50 taxi fare plus $150 accommodation). Accordingly, Mr and Mrs Hitchman can each claim a deduction of $100.

    End of example

    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 below.

    Borrowing expenses

    These are expenses directly incurred in taking out a loan for the property. They include loan establishment fees, title search fees and costs for preparing and filing mortgage documents - including mortgage broker fees and stamp duty charged on the mortgage.

    Borrowing expenses also include other costs that the lender requires you to incur as a condition of them lending you the money for the property - such as the costs of obtaining a valuation or lender's mortgage insurance if you borrow more than a certain percentage of the purchase price of the property.

    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.

    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 15: 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 2008, they would work out the borrowing expense deduction for the first year as follows:

    Year 1

    Borrowing expenses × (number of relevant days in year ÷ number of days in the 5-year period) = maximum amount for the income year × (rental property loan ÷ total borrowings) = deduction for year

    $1,670 × (349 days ÷ 1,826 days) = $319 × ($170,000 ÷ $209,000) = $259

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

    Year 2

    $1,351 × (365 days ÷ 1,477 days) = $334 × ($170,000 ÷ $209,000) = $272

    Year 3

    $1,017 × (365 days ÷ 1,112 days) = $334 × ($170,000 ÷ $209,000) = $272

    Year 4 (leap year)

    $683 × (366 days ÷ 747 days) = $334 × ($170,000 ÷ $209,000) = $272

    Year 5

    $349 × (365 days ÷ 381 days) = $334 × ($170,000 ÷ $209,000) = $272

    Year 6

    $15 × (16 days ÷ 16 days) = $15 × ($170,000 ÷ $209,000) = $12

    End of example

    Deduction for decline in value of depreciating assets

    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 assessable 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. However, a capital works deduction may be allowed for some of these items - 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. The Depreciation and capital allowances tool will help you with the choice and the calculations.

    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 (Note) × (days held [Note 2] ÷ 365) × (200% ÷ asset's effective life)

    base value*

    x

    days held**
    365  

    x

              200%        
    asset's effective life

    Note: 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.

    Note 2: 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 (Note 3) × (days held [Note 4]) × (150% ÷ asset's effective life)

    Note 3: 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.

    Note 4: 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 × (days held [Note 5] ÷ 365) × (100% ÷ asset's effective life)

    Note 5: 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.

    Under either the diminishing value method or the prime cost method, the decline in value of an asset cannot amount to more than its base 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 by any entity for a taxable purpose, or for the purpose of producing exempt income or non-assessable non-exempt 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, and
    • 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.

    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 of depreciating assets:

    • Taxation Ruling TR 2008/4 is applicable from 1 July 2008
    • TR 2007/3 is applicable for the period 1 July 2007 to 30 June 2008
    • TR 2006/15 is applicable for the period 1 January 2007 to 30 June 2007
    • TR 2006/5 is applicable for the period 1 July 2006 to 31 December 2006
    • TR 2000/18 (and its associated schedules) is applicable for the period 1 July 2001 to 30 June 2006.

    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 Taxation Ruling TR 2000/18, 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 for a taxable purpose 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, and
    • 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 depreciating asset in which you have an interest cost more than $300 - see Partners carrying on a rental property business.

    Example 16: Immediate deduction

    In November 2008, 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 assessable income, provided he is not carrying on a business from the rental activity.

    End of example

     

    Example 17: 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 identical, or substantially identical, and the total cost is more than $300.

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

    End of example
    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 whose cost is less than $1,000 (after GST credits or adjustments) 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 and:

    • that has an opening adjustable value for the current year of less than $1,000, and
    • for which you have worked out any available deductions for decline in value under the diminishing value method.

    You work out the decline in value of an asset you hold jointly with others based on the cost of your interest in the asset. This means 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 in that income year and in later income years. However, this rule 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 of your use of the asset that will be for a taxable purpose over its effective life (for a low-cost asset) or the effective life remaining at the start of the income year for which it was allocated to the pool (for a low-value asset). 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 further information about low-value pooling, including how to treat assets used only partly to produce assessable income and how to treat the disposal of assets from a low-value pool, see the Guide to depreciating assets.

    If you are an individual who owns or has co-ownership of a rental property, you claim your low-value pool deduction for rental assets at item D6 on your tax return - not at item 21 on your tax return (supplementary section).

    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 such assessable amounts at item 24 Other income on your tax return (supplementary section) - not at item 21.

    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.

    Note: 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 - a capital gain or capital loss might arise to the extent that you so used the asset.

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

    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 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 separate values for depreciating assets are not included in the sale agreement for your rental property when you purchase it, you may be required to demonstrate the basis of your valuation.

    Generally, independent valuations that establish reasonable values for depreciating assets satisfy Tax Office requirements. In the absence of an independent valuation, you may need to demonstrate that your estimate provided a reasonable value. Considerations would include the market value of the asset compared to the total purchase price of the 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 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.

    Example 18: Working out decline in value deductions

    In this example, the Hitchmans bought a property part way through the year - on 19 July 2008. 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 2008–09 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 2008–09 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
    (Note)

    Totals

    $4,200

    $4,200

    -

    -

    $830

    $3,370

    Note: As the adjustable values of the curtains and the carpets at the end of the 2008–09 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 (2009–10).

    End of example

     

    Example 19: Decline in value deductions - low-value pool

    In the 2008–09 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.

    Low value asset decline in value calculation

    Asset

    Taxable use percentage of cost or opening adjustable value

    Low-value pool rate

    Deduction for decline in value in 2008–09

    Various

    $1,679

    37.5%

    $630

    Low cost asset decline in value calculation

    Asset

    Taxable use percentage of cost or opening adjustable value

    Low-value pool rate

    Deduction for decline in value in 2008–09

    Television set (purchased 11/11/2008)

    $747

    18.75%

    $140

    Gas heater (purchased 28/2/2009)

    $303

    18.75%

    $57

    Total low-cost assets

    $1,050

    18.75%

    $197

    Total deduction for decline in value for year ending 30 June 2009

    Total deduction for decline in value for 2008–09 is $827 ($630 plus $197).

    Closing pool balance at 30 June 2009

    Low-value assets: $1,679 minus $630 equals $1,049

    Low-cost assets: $1,050 minus $197 equals $853

    Closing pool balance for 2008–09 is $1,902 ($1,049 plus $853).

    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, or
    • 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.

    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 - Types of rental property construction that qualify for deduction

    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 (Note 1) intended to be used on completion to provide short-term accommodation to travellers (Note 2)

    20 July 1982 to
    17 July 1985

    Certain buildings (Note 1) intended to be used on completion to provide short-term accommodation to travellers (Note 2)

    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 (Note 1) intended to be used on completion to provide short-term accommodation to travellers (Note 2)

    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 (Note 1) intended to be used on completion to provide short-term accommodation to travellers (Note 2)

    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 (Note 2) 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)

    Note 1: '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.

    Note 2: For more information, phone the Business Infoline on 13 28 66.

    Table 2 - Rate of deduction based on date construction started

    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%

    Note: 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 2. To be able to claim the deduction, the new owner must continue to use the building to produce income.

    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 20: Estimating capital works deductions

    The Perth property acquired by the Hitchmans on 19 July 2008 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 (note that 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 19 July 2008, they can claim the deduction for the 347 days from 19 July 2008 to 30 June 2009. The maximum deduction for 2008–09would be worked out as follows:

    Construction cost × rate × portion of year = deductible amount

    $115,800 × 2.5% × (347 ÷ 365) = $2,753

    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 item D9 Cost of managing tax affairs on your tax return.

    For more information about construction expenditure and capital works deductions, see Taxation Ruling TR 97/25 - Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements.

    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 – Note) 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.

    Note: 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 chapter 7 of the Guide to capital gains tax.

    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 Practice Statement Law Administration (General Administration) PS LA 2006/1 (GA) - Calculating the cost base and reduced cost base of a CGT asset if a taxpayer does not have sufficient information to determine the amount of construction expenditure on the asset for the purpose of working out their entitlement to a deduction under Division 43 of the Income Tax Assessment Act 1997.

    Example 21: Capital works deduction

    Zoran acquired a rental property on 1 July 1997 for $200,000. Before disposing of the property on 30 June 2009, 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 capital 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 after 27 February 1998 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 or us.

    Last modified: 23 Oct 2009QC 27952