For many Australians, a beach house or a country retreat is the ultimate lifestyle purchase but given the potentially substantial costs involved, often the only way to make it pay is to rent your holiday pad out to the public for part or all of the year.
Any income you earn from renting out your holiday home is taxable and needs to be declared on your tax return but because the income is taxable, you can also claim a tax deduction for any costs incurred in earning that income.
Read more from Mark Chapman:
Every year, the Australian Taxation Office (ATO) looks closely at tax claims which relate to holiday homes to ensure that people aren’t over-claiming their tax deductions.
The boom in holiday home ownership throws up particular challenges for the taxman, both in making sure that they know exactly who owns what and also in making sure that taxpayers aren’t rorting the system.
As part of that process, the ATO has made it very clear that holiday rentals are high on its list of targets for compliance action where taxpayers do the wrong thing.
The two holiday home tax traps you need to know
So what do you need to know to get it right?
If you rent out your holiday home during the period you’re not using it, you need to declare the rental returns as income.
You can only claim deductions for the periods the property is rented out or is genuinely available for rent. Periods of personal use can’t be claimed. This is particularly important for holiday homes, where the ATO regularly finds evidence of home-owners claiming deductions for their holiday pad on the grounds that it is being rented out, when in reality the only people using it are the owners, their family and friends, often rent-free.
The ATO lists a number of factors they look for which indicate a property is not genuinely available for rent, including:
If it is advertised in ways that limit its exposure to potential tenants – for example, the property is only advertised through a card in the newsagent window or is only rented out during periods of the year when the likelihood of anyone renting it is very low.
The location, condition of the property, or accessibility to the property, mean that it is unlikely tenants will seek to rent it
You place unreasonable or stringent conditions on renting out the property that restrict the likelihood of the property being rented out, such as looking to charge a rent that is substantially higher than others are charging for similar properties in the same area or preventing families with children from renting, or even demanding references from prospective holiday renters.
You refuse to rent out the property to interested people without adequate reasons.
Other reasons the ATO may push back on your holiday home
Where the property is let at less than market rent – to friends or relatives for example, who might pay you a token amount – income tax deductions for that period will be restricted to the amount of rent received.
The costs to repair damage and defects existing at the time of purchase or the costs of renovation also cannot be claimed immediately. These costs are deductible instead over a number of years. Expect to see the ATO checking such claims and pushing back against claims which do not stack up.
Likewise, where only part of the holiday home is let, deductions are restricted to those expenses which relate either directly to the rented area or to a proportion of expenses which relate to shared areas which are available for both you and your guests to use (such as a communal lounge or kitchen).
Another ATO concern is that husbands and wives are in some cases splitting income and deductions so that the bulk of the tax benefit goes to the higher earning spouse, even though the property is actually owned 50:50. Make sure that if you jointly acquire a property with your spouse, everything – income and deductions – needs to be split equally.
Holiday home costs you can’t claim at tax time
There are also a number of costs which you can’t deduct, including costs associated with:
Acquiring and disposing of the property, including conveyancing costs, advertising costs and stamp duty. These costs would normally be of a capital nature and would be added to the cost base of the property
Expenses you don’t actually incur as the owner of the property, for example costs in relation to the property which the person renting the property pays
Expenses not related to the rental of the property, for example interest on a loan which might originally have related to the property but where additional funds have been drawn down to fund private activities
Travel expenses associated with renting the property. Prior to 1 July 2017, you could claim a deduction for the costs of any travel you undertook to visit the property provided the visit was related to the management of the property. From 1 July 2017, such claims are no longer possible.
There are other expenses which, whilst not immediately deductible, can be claimed over a number of years.
These include borrowing expenses (ie, those costs linked to the financing of the property such as title search fees, loan establishment fees, stamp duty on the mortgage, etc), depreciation costs on assets used in the building (such as air conditioners, hot water systems, etc) and capital works deductions (such as costs spent on altering, improving or extending the structure of the building).
But remember, you can only claim the proportion of costs which relate to periods the property was available for rent.
Importantly, the ATO now has access to numerous sources of third party data, including access to popular rental listing sites for both long term and holiday rentals, so it is relatively easy for them to establish whether a claim that a property was ‘available for rent’ is correct.
In all cases, H&R Block is advising taxpayers to be careful – don't claim what you're not entitled to and make sure you have records to support and justify every item. Tread carefully – as the ATO is watching you!