Property investors' ultimate tax time guide for 2023

Garreth Hanley:
This is With Interest, a business, finance and accounting news podcast, brought to you by CPA Australia.

Elinor Kasapidis:
Hello and welcome to CPA Australia's With Interest podcast, bringing you this week's need to know information for business and accounting professionals. I'm Eleanor Kasapidis, senior manager tax policy at CPA Australia. It's the 20th of June and tax time is right around the corner. Welcome to the third instalment of our tax time podcast with Tim Loh, Assistant Commissioner at the ATO. Welcome back Tim.

Tim Loh:
Thanks El. Thanks for having me.

Elinor Kasapidis:
As technology reduces barriers to investments globally, Australians are increasingly investing in a broad range of asset types through many markets and exchanges and property investment remains a firm favourite. While everyone loves building their wealth tax may not necessarily be something they think about, they might not even know they need to pay tax. So Tim, let's dive in. Starting with property investments, rental income and expenses are a clear a t o focus this year. What do property investors need to remember when it comes to tax time?

Tim Loh:
Thanks. El rental properties are definitely on our radar this year. It's one of our three focus areas and the reason for that is we see a lot of errors when it comes to rental properties. When you have a rental property, their odds are you probably have a loan and interest to pay on that loan. In relation to your rental property interest expenses account for about 42% of the tax gap for rental properties. So for those who may not know, the tax gap is an estimate of the difference between the amount of tax the ATO collects and what we would have collected if every taxpayer was compliant with the tax laws. Now the ATO has found that 9 out of 10 tax returns that reported rental income and deductions contain at least one error and about 87% of the rental returns were lodged by tax agents. Now because of this, I'm urging registered tax agents to ask clients a few extra questions in this tax time and also for clients to ensure that they provide all their records to their tax agent to enable their tax agent to complete the return correctly the first time.

Elinor Kasapidis:
That's really a clear message I think from the ATO. Taking reasonable care, making sure that clients do understand the records that they need to keep. And that interest expense gap is really around overclaiming expenses that are not directly related to the rental property itself. So let's talk a little bit more. What are some of the issues?

Tim Loh:
Look we know many people redraw from their investment loans to buy personal items, such as cars like a Tesla or going on a holiday to Bali with their mates. And sometimes they bundle personal investment loans that result in smaller and or less repayments. Now we're not saying people can't do this, but we want them to be aware of their tax obligations before they make these decisions. Basically what it comes down to is if you've got a loan for 25 years, you must apportion that personal component for the life of the loan. And this remains true each time the loan is refinanced. So you can't simply pay back that private portion of the loan. Like interest every repayment also must be apportioned between the private and investment components. Calculations to correctly apportion interest can be complex as time goes on and therefore we recommend you factor this into your decision to adopt this particular loan structure. Now the interest and deductions must also be apportioned for periods the property was used for private purposes by yourself or family and friends, as a private portion of those expenses can't be claimed as a tax deduction.

Elinor Kasapidis:
Thanks Tim. Really it's not, like you say, it's not that you're saying keep it all in a single loan, but that flexibility by bundling and redrawing has tax consequences and your record keeping really needs to be spot on. Because you don't want to be claiming interest expenses associated with the trip to Bali or the school fees, right?

Tim Loh:
That's right.

Elinor Kasapidis:
Excellent. Now what about the repairs?

Tim Loh:
Look, we know initial repairs can be tricky to identify. We quite often see deductions in the first year of ownership are far higher than subsequent years as landlords prepare the property for rent and incorrectly claim all those costs immediately. Now the important distinction to remember is whether the defect damage or deterioration exists at the time of purchase. If you're not repairing it straight away or you didn't know until a later date and only the amount related to gaining or producing income can be claimed as a deduction, otherwise it's considered to be a capital expense.

Elinor Kasapidis:
So when you talk about this revenue deduction versus capital expense, what's the ATO looking for?

Tim Loh:
Look it's been a focus of our audit programme for several years to make sure taxpayers and tax agents get it right. So we're really focused on educating taxpayers and tax agents when it comes to the rental properties. Our next step is to test at the leverage effect and ensure it's being used across years for taxpayers and across client bases for tax agents. Now because many rental properties are part of strata arrangements, it's also worth mentioning that body corporate fees, like general purpose or special purpose funds can include amounts for capital works or improvements or repairs of a capital measure which aren't immediately deductible.

Elinor Kasapidis:
So at the simplest level, is it fair to say that when you're doing these reviews you're seeing capital items being deducted or treated as revenue and they're trying to front end a lot of the expenses when really it should be smoother over time?

Tim Loh:
Yeah, that's right. So it's really important that tax agents and their clients are looking really carefully at what's going into these particular funds to make sure they in fact deductible over time rather than just assuming that it's considered to be like an initial repair and incorrectly claiming it.

Elinor Kasapidis:
And when you see those body corporate fees or some of those invoices, you really need to separate the revenue and the capital expenses, right?

Tim Loh:
Yeah, that's right El.

Elinor Kasapidis:
So any more information available as always from the ATO?

Tim Loh:
On our website, we've got some fantastic information that we've updated recently. We've got our repairs, maintenance and capital expenditure factsheet which is contained in our investor's toolkit on the ATO website and there's a quick reference card in there to help you out and that can be really useful whether you're doing your tax return yourself or whether you are using a registered tax agent because it can give you some really good guidance as to what to expect, and what you can claim when it comes to your rental property.

Elinor Kasapidis:
I do like the ATO guidance, particularly for those common situations, and we'll ensure that we include those in the show notes. What are your key tips Tim, when it comes to rental income?

Tim Loh:
Yeah, when it comes to rental income, it covers all types of rent, whether it's long-term rent or short-term rent, if you're renting on Airbnb or Stayz. And it includes for any part of your home. So if you're advertising a room as I said before on you know, Airbnb and Stayz, or whether you're receiving irregular payments like insurance payouts and rental bond money that's retained, you need to include that in your tax return. Now if you buy a property to live in that already has tenants but are planning to move into it, you still need to report any rent received and just keep in mind that you are also are eligible for any deduction for that particular period as well. Now what we're seeing through some of our audit programmes is we're finding that net rent is being reported with deduction's then been claimed in addition to this, that's effectively double dipping on these deductions.

Tim Loh:
And what we'll be doing this year is we'll be sharing this intelligence with property managers, but it's also something a registered tax agents need to keep an eye out for. Registered tax agents need to make sure that the gross rent is included and then property manager fees and other expenses are listed as expenses at the other labels of the tax return. It's really important, because you know tax agents are really important partners in the system that they need to use their expertise, because if it doesn't look right it's really important that you ask questions of your clients.

Elinor Kasapidis:
And you're right because our members will often observe that perhaps their clients don't know the difference between gross or net or it's perhaps keeping an eye out. Going, well what is the margin, what's the return on this investment? Does it make sense? So there are a few sort of checks to look out for. Right.

Tim Loh:
That's a really good tip El. Yeah, you can look at margins and that's really good, just a sense check to make sure that what's been put in the tax return is right.

Elinor Kasapidis:
The other thing as well of course is educating the clients to make sure that they themselves keep those records properly and hopefully do some of that work upfront. We talked earlier in our podcasts about digital records and making sure things are done properly.

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Elinor Kasapidis:
So what do you think about the role of registered tax agents in this space?

Tim Loh:
Yeah, it's really important that it's a two-way street. Registered tax agents can only work with the information they gather from their clients and we know some clients won't know everything they need to tell their agent. As I mentioned before, we do expect agents to ask the right questions and make sure the appropriate records are being kept to ensure their client's returns are right. Obviously it's on the client to provide those records to the registered tax agent and it's really important for the clients to understand that they're on the hook if the tax return is wrong. But as I said before, it's a really a two-way street and we refer to those toolkits before they're really important fact sheets and they're really easy to read. So whether you are lodging your tax return yourself or using a registered tax agent, have a peak of them, it can really help you get your records Right.

Elinor Kasapidis:
And there has been also some buzz recently around holiday homes. Are these treated any differently to normal rental properties?

Tim Loh:
No. The location of the property or the fact you've chosen the short-term rental strategy doesn't change your obligation to report your rental income. As I said previously, income earned through sharing economy platforms need to be reported on your return. But we're also seeing some concerning behaviour by a small group of taxpayers with properties and holiday locations. They're claiming on average six times more in deductions than income earned and we're finding many of these taxpayers are using their holiday homes themselves or allowing friends and relatives to use them without apportioning their expenses for the private use. Now some of them are even placing heavy restrictions on the way they advertise their property for rent to discourage potential renters. So we see things like excessive minimum stays or reduced availability like blocking out Christmas holidays and Easter holidays and charging higher rental rates than equivalent properties in the area. So this tells us taxpayers aren't that serious about earning investment income from their property and they're looking to subsidise their rental property on the Australian taxpayer.

Elinor Kasapidis:
Not cool, huh?

Tim Loh:
Not good.

Elinor Kasapidis:
So I think at the end of the day the holiday house arrangement is no different to any other kind of rental thing. And you did mention earlier as well, if you are renting out a room for board for example, that income is accessible.

Tim Loh:
Yeah, that's exactly right. And something to kind of keep in mind is that there can be capital gains tax consequences of using your main residence and renting out a room through your main residence when you do eventually sell that property.

Elinor Kasapidis:
And let's talk a little bit more about when you're selling the property. What are some of the things to consider?

Tim Loh:
When a rental property is sold, it's a disposal for capital gains tax purposes and must be reported in your tax return. Now if your clients lived in the property, they can make the choice to use the main residence exemption including the six-year rule if it applies. Now if we've also seen a pickup recently where registered tax agents with foreign resident clients have been trying to claim the main residence exemption, foreign residents are only entitled to the exemption if they satisfy the requirements of the life events test. Now it's not met, they aren't entitled to any main residents exemption, even if they were a resident for some of their ownership period. Now there are many circumstances where a main residents exemption should be reported on a tax return. Our new fact sheet is part of our investors toolkit and can help with what to do for many different scenarios.

Elinor Kasapidis:
And again, it's that whole questioning around are you a foreign resident, are you an Australian tax resident? Especially with people going between countries all the time.

Tim Loh:
That's right El.

Elinor Kasapidis:
Now we've talked a lot about rental because that is a focus area of the ATO, but crypto and digital assets have also had an interesting ride throughout 2023. Australians invested billions in these products and unfortunately for some they've also lost significant amounts. What does this mean for their tax affairs?

Tim Loh:
Look, some people think crypto's anonymous, but we acquire data from a number of crypto asset exchanges. And we know over a million Aussies holding crypto accounts with over a third transacting for the first time in 2022. Now a big thing we saw last year was people not having records and it's important to stay on top of this as crypto is obviously volatile and not only can you have capital gains, but you can also have capital losses as you said before El. And when it comes to records, I encourage setting reminders, export transaction histories regularly at least every three months and particularly before closing an account as the records could be lost, which could impact your tax return. There are plenty of reputable Australian crypto tax calculators, which are free and low-cost services that sync exchange and wallet accounts. So that's something I would encourage people to look into. For our tax professionals listening in, if you are finding that the number of clients in your practise with crypto is growing, you may consider getting an enterprise solution to help you manage their crypto taxes. Now when it comes to actually reporting the crypto in the tax return, most people are investors, meaning they need to report their amounts at the capital gains tax label. There's no specific label for crypto on the capital gains tax schedule, so you just need to put it under other assets.

Elinor Kasapidis:
Now in the whole crypto world, and I've learned a lot over the past few years, there are all these different terms that come up. Can you give us some examples of income that should be reported that might not immediately come to mind?

Tim Loh:
Yeah, good question El. For staking rewards, defy arrangements and airdrops income goes under other income and needs to be declared even if the crypto asset is still held by you.

Elinor Kasapidis:
What happens when you are transferring from one wallet to another?

Tim Loh:
If you're transferring crypto from one wallet to another wallet that you own, that isn't going to be a disposal for capital gains tax purposes. But one thing people do often overlook is that when you're transferring to or from an exchange or a liquidity pool or using a smart contract that may be disposal of that crypto. So it really depends on the rules of the platform or exchange or the code of a particular smart contract. One thing to note when it comes to crypto, is that you've got to convert all your amounts into Australian dollars before you calculate your income or the CGT amount in your tax return. It's also important that any capital losses are included in your tax return as it will reduce the likelihood of us contacting you when the losses are used to offset capital gains later down the track. Whether that's from crypto or other investment assets that you have.

Elinor Kasapidis:
That's actually a really important point because I think there are taxpayers out there who may be incurring capital losses, but because it's, there's no accessible income for example, against it, they may not be reporting it. So what you are saying is year-on-year actually record your capital losses so that the ATO’s got that track of those losses over time. Is that right?

Tim Loh:
That's exactly right El. So yeah, if you don't do that and then you subsequently then offset those capital losses against other capital gains, we'll be asking a few questions because we haven't seen that in your tax return. So it's just really important just to make sure we've got that paper trail in your tax return this year.

Elinor Kasapidis:
And what about unrealised versus realised losses? What's the difference?

Tim Loh:
Yeah, when it comes to those unrealised and realised losses, you can only claim a capital gains tax loss when you've actually sold the particular asset. So if it's crypto, you've exchanged that crypto or you've sold that onto the exchange. If you have incurred an unrealized or paper loss, uh, you can't claim a capital loss until you've actually disposed of the crypto.

Elinor Kasapidis:
So really crypto, like any other investment asset, the rules are the same and it's like shares. If you have different kinds of events, you've got to look at the tax rules.

Tim Loh:
That's exactly right El, it’s exactly the same as shares. So yeah, it's the same rules, you just apply it to a different asset class.

Elinor Kasapidis:
Excellent. So when it comes to assets and investments more generally, we've mentioned the data matching and the data collection activities, which includes investment loans, property management data, digital assets, exchange information including shares and crypto. Some of this information is matched to help with tax return preparation. Other times the ATO will get in touch a little later, and it can be a few years down the track. So what does this mean for investors at tax time?

Tim Loh:
Yeah, that's right El. We receive data from various sources to populate their income tax return that you need to lodge. And we know that that 90% of the boxes pre-filled on an individual tax return remain unchanged by the taxpayer. So it's a real time saver for people trying to lodge their tax return this year. We also received property sales information from state and territory officers of the state revenue. So when you do complete your tax return, we're able to remind you through our pre-filling services about property you've sold during the year. So think of these reminders as you know, like sometimes from the bank you might get a reminder that your, your credit card statement's due. If you bank with CBA, they'll often remind you that your credit card bill is due. And so from our perspective, we're all about trying to get it right the first time, prevention before correction rather than chasing you down later in the year to make sure that you've included that information into your tax return.

Tim Loh:
One thing to also note is when it comes to investment income, it's not always pre-filled. So it's really important, and I'm going to sound like a broken record, to keep those good records and declare anything that's missing when you do lodge your tax return. Now we do sometimes identify possible errors in a tax return by using data matching and risk models to your earlier question. And what we do is when we determine if the claims are above a reasonable threshold based on claims in similar demographics, for example, the location and type of property where you will use data-driven treatments to correct tax returns when we have a very high degree of confidence that the claim is incorrect.

Elinor Kasapidis:
Thanks Tim. And I think there's a lot of messages in there. So it's not that you have a hundred percent pre-fill information that taxpayers can rely on. They still need to take ownership of reporting all the income, but also increasingly the ATO does have an eye over everything that's going on, all of the different transactions and disposals, which makes the record keeping for expenses very important because in the past, you know, you don't declare the income, you don't claim the expense, whatever. Whereas now it's really important to be getting everything right. That's

Tim Loh:
That’s right El.

Elinor Kasapidis:
So thanks Tim. Some really great information covered here and I will say rental property investors are on notice this tax time. In our fourth and final tax time episode next week we'll talk about scams, cybersecurity, and how to navigate tax time more easily. If you're interested in knowing more about what we've covered today, our show notes contain links to further information including the AT O website. If you're looking for advice, speak to a registered tax agent. If you like what you've heard today, subscribe on your favourite podcast app. From all of us here at CPA Australia, thanks for listening.

Garreth Hanley:
You've been listening to With Interest, a CPA Australia podcast. If you've enjoyed this episode, help others discover With Interest by leaving us a review and sharing this episode with colleagues, clients, or anyone else interested in the latest finance, business and accounting news. To find out more about our other podcasts and CPA Australia, check the show notes for this episode. Hope you can join us again for another episode of With Interest.