The Australian Tax Office (ATO) will look closely if it knocks on your rental property door. Knowing what can and cannot be deducted, as a legitimate tax expense can be a minefield when it comes to investment property.

Due to the complexity of the Tax Act, there are often amounts spent on a property that, if not treated correctly, could cause audit problems. These include:

• incorrectly claiming a deduction for costs relating to the buying of a property
• over-claiming interest where a loan includes amounts borrowed for both private and investment purposes
• incorrect asset values being placed on depreciable fixtures and fittings
• borrowing expenses incorrectly claimed
• travel expenses being over claimed

Under the Income Tax Act, capital costs associated with buying a property must be distinguished from income costs. Capital costs are not deductible in the year they are incurred while income costs are claimable in full. Examples of deductible income costs include interest, insurance, rates, and agents’ fees.

As a rule, amounts spent before a property is rented are capital costs. Examples of these include stamp duty or legal fees, and repair costs to put the property into a condition where it can be rented.

These are added to the purchase cost and used to decrease any capital gain. They cannot be used to increase a loss on negative gearing.

Some costs of repairs will also be classed as capital even when they are paid for after a property has started earning income. In these cases, if the problem existed at the time of purchase but the repair took place after tenants moved in, the repair cost is classed as capital. An example would be a house bought with a rusty roof and a few small leaks. If the roof is repaired or replaced after being rented, the costs are not deductible and must be added to the cost of the property.

We strongly recommend that you refer to your tax agent or financial adviser for advice on taxation and deductions.