Tax implications with personal use of holiday property

Previously I interviewed Michael about his long-term rental investment unit. Now it’s time to talk about what deductions he can claim for his holiday house, which his family uses ech year during the Christmas break. Michael & Jenny are experienced investors with many years of experience. Much like our team of mentors who are available to coach you in entering the real estate investment arena, and long-term, full life-cycle portfolio management.

Jim: So Mike, what do you deduct for your holiday home?

Michael: Well, in addition to our long-term rental units, our holiday house is available for rent. So there are expenses I can claim immediately, and some that I claim over a number of years. But there’s also some I can’t claim at all.

Jim: What you mean “can’t claim at all”?

Michael: Well, things like the actual cost of buying and selling the property and any initial repairs I had to make. Those costs can only be claimed when working out any profit upon disposal or sale of the property, which is called “the capital gain” when I sell the property. And if I owned the property equally with my wife Jen, I could only claim half of the expenses and I would have to declare half the income.

Jim: So we’ve talked about what you can’t claim. What can you claim? You mentioned immediate deductions.

Michael: Yeah, sure. What comes to mind the things like interest on the bank loan, council rates, and travel costs when I collect the rent and do repairs myself.

Jim: There are also three types of expenses that may be claimed over a number of years, this is called “amortisation”. First, mortgage set-up costs like loan establishment fees; these are usually claimed over five years. Then, you can also claim for the wearing out of assets, known as depreciation, such as carpets and appliances. And thirdly there are the actual building costs, these are generally claimed at 2.5% per year. This seems a little counter intuitive, because the ATO assumes that the value of the building is reducing through wear and tear, which it is, but in reality the value is actually increasing with inflation. So we get to have our cake and eat it too; we can reduce our tax payable by deducting the depreciated amounts from our gross earnings each year, while increasing our nett worth as the propery gains value. Although, the ATO eventually gets their taxes if we sell the property with a one-time “capital gains tax”, but there are ways to minimize that too.

So Michael, what happens if you only rent the property out for some of the year, as you seem to be doing?

Michael: Then I need to divide up the expenses. So in my case with the holiday house, I can’t claim a deductions for when I use the house myself.

Jim: And what if you rent the property out of the reduced rate, say to family or friends?

Michael: In that case, what I can claim is usually limited to the amount of rent that I received. Even if expenses are more than the total rent received.

Summary

This might sounds complicated, but it’s not really. Let’s look at what happens when Michael stays in his house for one month out of the year. Because this is for his personal use. He can’t claim deductions for this period and here’s how he’d work it out. For all the expenses that occur evenly throughout the year, he could simply divide them by 12 to get a monthly rate. That includes interest, council rates, insurance, and depreciation. He would then multiply the monthly amount by 11, to get a total that is tax deductable. So, if total expenses for the property are $24,000 for the year, then:

$24,000/12 = $2,000 per month
$2,000 X 11 – $22,000. Thus, Mike gets a $22,000 tax deduction from his top marginbal rate salaried earnings. A very happy ending indeed.

But some things, like electricity, are directly related to the usage period. So he’d look at the bill for that period and work out what he can’t claim.

If you only rent out part of your property, such as a with granny flat, then you can only claim expenses that relate to that part. As a general guide, you work it out on a floor-area basis and calculate what percentage of the floor area your tenant uses. And if your property is negatively geared, that is where the rental income is less than the loan interest and other expenses, then you may be able to claim the loss against your other income such as salaries and wages. But, be careful not to cook the books. The ATO uses complex algorithims to dedect tax fraud, you do not want to be audited.