Q: What is the difference between buying a property with someone else as ‘joint tenants’ as opposed to ‘tenants in common’?
When you buy a property as a co-owner with someone else, you can buy the property as ‘joint tenants’ or as ‘tenants in common’. The main difference between these two arrangements pertains to what happens to your interest in the property if (or more appropriately when) one of the owners dies.
Under a ‘joint tenants’ arrangement, if one of the owners dies, then the surviving owner will automatically inherit the deceased owner’s interest in the property. Therefore, it is common to see this type of arrangement between spouses, partners, or other close family members who intend for each other to inherit full ownership of the property upon the death of one of them.
On the other hand, if the owners hold the property under a ‘tenants in common’ arrangement, the deceased owner’s interest in the property will form part of their estate, which will be inherited by a beneficiary or beneficiaries of that estate who may or may not be the surviving owner. Therefore, it is not surprising that people who do not belong to the same nuclear family would often prefer the ‘tenants in common’ approach so that they could specifically pass their interest in the property to an intended beneficiary.
In both of these cases, unless the coowners are carrying on a rental property business (which usually involves a formal partnership agreement being entered into), the mere co-ownership of a property would not normally amount to a ‘general law partnership’. Nevertheless, for taxation purposes, the fact that the owners are ‘jointly in receipt of income’ from the property would mean that they are effectively treated as ‘tax partners’ of a ‘tax law partnership’.
While a partnership, whether it is a general law partnership or tax law partnership, is normally required to lodge a partnership tax return each year, the administrative practice of the Australian Taxation Office is to provide relief to a partnership from having to lodge annual partnership returns if the tax partners merely co-own rental properties as passive assets. However, speak to your accountant if you are unsure of your tax lodgement obligations.
Q: What is the tax treatment of renovation costs?
There are many reasons why you may want to renovate your investment property, especially if market conditions are more favourable to tenants (eg, oversupply of rental properties) and landlords have to compete for them.
While you may view the cost of renovations as a single expenditure, the tax treatment of the expenditure is not as straightforward because different costs that make up the expenditure may be treated differently for tax purposes.
“A structural improvement that is affixed to land and buildings will generally qualify for capital works deductions, while a stand-alone depreciating asset will qualify for depreciation deductions”
At the outset, the cost to restore something back to its original condition due to the wear and tear caused by tenants while the investment property was rented out is generally taxdeductible, provided that it is not related to ‘initial repairs’ (which are done to damages that existed at the time the property was initially purchased). Initial repair costs are generally considered capital in nature – they are not taxdeductible upfront but may be included in the cost base of the property for capital gains tax purposes and/or eligible for depreciation or capital works deductions.
The cost of restoring something over and beyond its original condition would normally constitute an improvement, rather than a repair, which is also considered capital in nature and is not tax-deductible upfront. However, the cost may be included in the cost base of the property for capital gains tax purposes and/or eligible for depreciation or capital works deductions, depending on the nature of the work done.
Having said that, if the restoration work involves the use of a modern equivalent of the original material that surpasses its predecessor in quality and longevity but the purpose of the work is merely to restore something back to its original condition, the work done will still be considered a repair rather than an improvement, which is tax-deductible upfront.
Further, the replacement of an entire functional unit is generally treated as capital in nature and is therefore not taxdeductible. However, the replacement cost may qualify for capital works or depreciation deductions, depending on the nature of what is being replaced.
Whether a capital expenditure is eligible for capital works or depreciation deductions will depend on whether the expenditure relates to something that is attached to the building (ie, a structural improvement) or is a freestanding functional unit that declines in value over time. A structural improvement that is affixed to land and buildings will generally qualify for capital works deductions, while a stand-alone depreciating asset will qualify for depreciation deductions.
Generally, from a tax perspective, depreciation deductions are usually more valuable than capital works deductions as the cost of a depreciating asset is depreciable over the effective life of the asset under either a straightline or diminishing value basis while an expenditure for capital works is only eligible for a 2.5% claim per year on a straight-line basis.
By way of examples, tax-deductible repair costs (assuming that they are not initial repairs) include fixing a leaking tap, repainting damaged walls, replacing damaged guttering, or fixing a dishwasher that has stopped working. An example of a structural improvement is replacing a laminated kitchen bench top with a granite bench top, which may qualify for capital works deductions on the basis that it is affixed to the property. Replacing an entire rotten timber staircase with a new steel staircase amounts to a replacement of an entirety and given that it is also affixed to the property, the cost will qualify for capital works deductions.
It may sometimes be difficult to differentiate costs on composite work done on an investment property, especially when the tradesperson who undertakes the renovation work does not provide you with a detailed invoice that clearly dissects the costs into discernible components. To mitigate this potential issue, it may be advisable to ensure that the tradesperson could provide you with a detailed cost dissection before they are engaged to do the renovation work.
Q: I have used my investment property partly for private purposes during the year. What are the tax consequences of doing so?
Generally, if you use your investment property for private purposes, you will need to address the private use for tax purposes.
A way to address this issue is to apportion your tax deductions so that you are only claiming deductions that are related to the period during which the investment property was not used by you and was available for rent. This could be a labour-intensive approach because you will need to apportion every amount of tax deduction you wish to claim.
While tax deductions can generally be claimed as long as the property is available for rent, as distinct from it being actually rented, the property must genuinely be available for rent. It will not be sufficient, for instance, that you merely list the property for rent but you decline the applications received from prospective tenants to rent the property.
As an alternative, if your investment property is rented by you for private use from a separate entity that owns the property (eg, your spouse, a discretionary trust controlled by you, etc), rather than apportioning each tax deduction, you may opt to pay market rent to the entity that owns the property to account for the availability of the property for your private use. In which case, the entity that owns the property will not be required to apportion the tax deductions as the property would be taken to have always been available for rent.
An important point here is that you can only rent the property if the payer and payee are different tax entities. For instance, if you own the property or you and your spouse are joint owners of the property, you will not be able to pay rent to yourself.
If the entity that owns the investment property happens to be a private company of which you or your associate is a shareholder, it will be highly advisable that you pay market value rent to the company for the availability of the property to you as a shareholder or an associate of a shareholder of the company. Otherwise, the market value attributable to the availability of the property for your private use may be treated as a deemed unfranked dividend in the hands of the relevant shareholder or associate under the infamous ‘Division 7A rules’.
Whether you should apportion your tax deductions or pay market value rent for your private use of your investment property will depend on whether the option you choose would result in net income or a net loss for the income year. For instance, if the payment of market value rent for your private use of the property would give rise to a net loss while not paying such rent but apportioning the rental expenses would give rise to net income, the former may be a better option for you from a tax perspective. Therefore, you should really do your sums before making that decision.
Q: I thought all losses for tax purposes were the same. What is the difference between a revenue loss and a capital loss?
Broadly, there are two types of losses from an income tax perspective – revenue loss and capital loss.
Revenue loss is incurred when your total assessable income in a given year exceeds your total allowable deductions. For instance, assuming that you own a single rental property that is negatively geared and the net loss on the property exceeds your other income, you will have a net revenue loss for the year.
Capital loss is incurred when the reduced cost base exceeds the capital proceeds in a capital gains tax event. A common example pertains to the sale of an investment property where the sale price is less than the reduced cost base of the property, which will give rise to a capital loss on the sale.
Subject to any applicable loss recoupment rules (different rules apply to different entities), a revenue loss is generally more valuable than a capital loss because a revenue loss can be used to offset against both assessable income or capital gains. In contrast, a capital loss can only ever be used to offset a capital gain.
Due to these differences, it is important that you keep good record of the type of losses you are carrying forward to ensure that they are applied correctly as they are recouped in future.