Investment property owners are coming under the microscope of the Australian Tax Office for incorrectly filling out their tax returns.
The ATO says around 90 per cent of the 1.7 million Australian landlords are filling out their net income from rental properties incorrectly, costing the Federal Government around $1.3 billion in lost revenue.
Misusing investment loans for things like holidays or school fees and incorrect claims for renovations will be the main focus of the crackdown.
Banks and other lending financial institutions are being approached by the ATO to provide their clients’ personal financial data to check it against property use, income and expenses.
On top of that, the ATO is also contacting property managers to provide information about their clients to match that against tax returns, income tax and capital gains tax payments.
“We have embarked on a process to collect data that can be used to help individual taxpayers get their tax return right in the first place as well as better target those individuals who may be under-reporting their income or over-claiming deductions,” the ATO said via a spokesperson.
Outgoings for an investment property are tax deductible and a big portion of that offset amount is the interest portion of a loan.
The crackdown comes as the Federal Government looks to save money wherever it can to repair the budget deficit ahead of this week’s Budget release.
The three common issues the ATO says need to be tightened are using investment loans for private spending, claiming costs for repair rather than capital works, and claiming expenses for private use of the property.
The concern is property investors are borrowing more than they need so they can spend on other investments or their own private lifestyle using the money that they have claimed at a loss and offset against other income.
Tax partner at BDO, Mark Molesworth, told the Australian Financial Review that interest payments on loans are only tax deductible if used for generating income, which of course mortgage payments on investment properties certainly are.
“Redrawn funds will not give rise to tax deductions for interest where the redrawn amounts are used for private purposes,” he said.
“If you redraw funds for private purposes and then repay them, a proportion of the loan will still be taken to be for private purposes, and some interest will be denied deductibility until the loan is entirely repaid.
“This is because the repayment of the redrawn amount is applied proportionately to the income-producing and private purposes. It’s not an obvious conclusion, and this is most likely what trips up the majority of rental property owners who are trying to do the right thing.”
The problem arises when it becomes difficult to decide whether spending is on ‘repairs’ or on ‘capital’, with repairs referring to the costs associated with routine work that maintains a property as opposed to capital expenditure which increases the value of the property.
Under the crackdown, errors discovered by the ATO will mean a pause will be put on the relevant tax return while the taxpayer has an opportunity to explain. If a tax return has already been processed the ATO can investigate the claims and then if necessary require taxpayers to review and amend their tax return, with penalties of up to 75 per cent of the missing tax payments facing the transgressor.