Article - West Australian, Perth

When it comes to claiming deductions, the Australian Taxation Office finds many landlords get it wrong because they don’t know better. The single biggest deduction for most who have borrowed to invest is the interest costs on the mortgage. That’s no problem, as the interest costs will be given on the lender’s statement to the investor.

But a common mistake made by landlords is to claim the interest costs for the whole 12 months when the investor has used the property for some of the year, says a Sydney tax partner with Sydney accountants and advisers HLB Mann Judd, Peter Bembrick. The costs being deducted must be apportioned for the time the property was rented or was available for rent, he says.

Often, landlords are not aware that they can claim the costs of borrowing to buy the investment property, Mr Bembrick says. The rules say the investor is allowed to claim 20 per cent of the borrowing expenses for each of the first five years after buying the property (or over the term of the loan in the unlikely event that it’s less than five years).

Mr Bembrick says the borrowing costs include the legal expenses and stamp duty on the mortgage but not the legal expenses or stamp duty on the transfer of the property Investors can also be confused by the concept of "initial repairs", Mr Bembrick says. This is where repairs are made to the property immediately after buying it. "But landlords are not able to get a deduction for that, even though they are repairs and not improvements, because the deterioration did not happen while the investor owned the property," he says.

"That is a big trap because the investor may have plans to spend on repairs thinking the costs of the repairs are deductible." It may be better to do the repairs over time so that more of the expenses can be claimed, he says.

Another big area of confusion among landlords is about what is a repair and what is an improvement or replacement of an asset.

Repairs include "restoring something to a working condition", according to the ATO. Mr Bembrick uses the example of a hot-water system because it is something that often needs to be repaired or replaced by landlords. The costs of paying the plumber and replacement parts can be deducted from the investor’s assessable income because it is a repair.

However, if the whole hot-water system is replaced, Mr Bembrick says, the ATO would most likely view that as a replacement of the "entire asset" and, like an improvement, it can be depreciated over time as per the ATO schedule of depreciable assets.

The tax office has an excellent guide called Rental Properties 2012, which can be downloaded from its website. Among other things, it lists more than 200 items and the depreciation they attract, and the "life" over which depreciation can be claimed.

When investors sell an investment property, they may be liable to pay capital gains tax. Capital gains tax applies to the difference between the "cost base" (costs of ownership) and what the investor receives for the property If a property has been held for more than 12 months, the investor may be able to reduce the capital gain on which capital gains tax is paid by the 50 per cent discount.

The tax office says that if the investor transfers the property into someone else’s name, the investor may still have to pay capital gains tax. Any capital losses can be used to offset capital gains. Whereas tax on capital gains must be paid in the year in which the gains are realised, capital losses can be carried forward indefinitely to be used to offset future capital gains.

Target: Paul Hogan settled $150 million dispute with tax office earlier this year.

Article written by John Collett, published in West Australian,Perth 23 July 2012