Tax traps highlighted with SMSF investment properties
With the ATO monitoring tax deductions for property more closely in general at the moment, a technical expert has outlined the main deductions available to SMSFs for property, and how this can vary depending on how the property is used.
SuperConcepts executive manager of SMSF technical and private wealth Graeme Colley explained that whether a client can claim a tax deduction or concession for a property owned by their SMSF will very much depend on the property type and how its used.
If an SMSF owns residential property, such as a free-standing home, terrace or apartment, the lease will usually be for set periods under a written lease for six months, a year or longer period as agreed, Mr Colley explained in an online article. Expenses relating to the property can be claimed from the day the property becomes available for lease.
“Any rent the SMSF receives less the relevant allowable deductions is included in the fund’s taxable income. Deductions can be claimed for rates and taxes, administration costs and maintenance of the property,” he said.
In terms of rates and taxes, Mr Colley said deductions for residential property can include body corporate fees and charges, council rates, water and electricity paid by landlord, but not those paid by the tenant and land tax.
Deductions for property administration, he said, can include insurance, advertising for tenants, property agent’s fees and commission, legal expenses and interest expenses if the property is not part of a limited recourse borrowing arrangement.
For property maintenance, the client can claim for cleaning the property, gardening and lawn mowing, past control, repairs and maintenance but not the cost of improvements, capital works deductions and travel expenses to inspect property, not deductible after 1 July 2017.
“Don’t forget, just like all taxpayers, SMSFs cannot claim a deduction for the total cost of improvements to a rental property when they are incurred. Capital improvements such as the cost of adding a new room, remodeling a kitchen or bathroom or adding a pergola will be used to calculate the cost base of the property for CGT purposes,” he explained.
“However, your SMSF can claim a capital works deduction based on the estimated cost of wear and tear to the property and any qualifying improvements.”
He also noted that since 1 July 2017 there are restrictions on claiming tax deductions for depreciating second-hand goods, but it is still possible to claim deductions on depreciating new assets.
A holiday house will have more expenses than a residential property due to the servicing and upkeep that may be required, explained Mr Colley.
“Also, your SMSF’s holiday house may include kitchen utensils, bed linen and furniture. A deduction is usually available for replacement of utensils, bed linen, depreciating furniture and more regular cleaning of the property,” he said.
He warned SMSF practitioners, however, that some clients may be tempted to use or let one of their relatives use the property in the off season.
“This can be a problem for the fund as the value of the property will be included in the fund’s in-house assets,” he cautioned.
“Your SMSF’s in-house assets are limited to no more than 5 per cent of the value of its total assets at market value. A breach of the in-house assets test can result in penalties being imposed by the ATO and could require the sale of the holiday house.”
Bed and breakfast
A bed and breakfast, is usually a short-term residential accommodation with breakfast included in the price.
In addition to expenses incurred for a residential property, a bed & breakfast may incur additional expenses including:
- Tea, coffee, milk, biscuits, bread and other consumable items
- Paper towels, soap, detergent, bath gel etc.
- Magazines, books, newspapers etc.
- Energy costs such as gas and electricity
- Internet, Wi-Fi and similar expenses
- Depreciation on kitchen appliances, heaters, air conditioners etc.
- Laundry and cleaning expenses
“It is worthwhile keeping payment receipts to substantiate deductions. Any expenses relating to the B&B should be paid by the fund where possible, say, using its own credit or debit card,” Mr Colley advised.
“However, this may not be practical, and if the trustees pay the expenses personally, reimbursement should be made as quickly as possible.”
An SMSF may own vacant land for various purposes such as a parking space for a business, farming land leased to a family business, or for property development, he said.
“If the land is used for genuine income-earning business purposes, the SMSF is entitled to a tax deduction for expenses,” he said.
“These could include rates and taxes, repairs to gates and fencing or other structures on the land such as roads.”
If the land is not held for income earning purposes, such as the intention to sell or develop it at a later stage, tax deductions are not permissible.
“Generally, under this scenario, expenses are added to the cost base of the property for capital gains tax purposes,” he said.
He also noted that there was some draft legislation which was released last year to ban deductions for expenses, effective 1 July 2019.
The legislation would apply to all vacant land owned by SMSFs and individuals, regardless of when the land was purchased.
“The legislation has some exceptions that continue to allow deductions: for expenses relating to vacant land which is used to carry on a business by a related party; or where the land is used in a business of leasing and where an unrelated party is involved,” Mr Colley noted.