Investors are frequently faced with questions and issues regarding the correct tax treatment of certain aspects of financial products, and sometimes the various features of these products. An important question that crops up on a regular basis is whether investors can claim tax deductions for interest and borrowing costs that they have incurred in the process of funding their investment.
Generally, it is not safe to simply assume that you will be entitled to claim such expenses, even if the issuer of the product suggests that these costs are tax deductible for some or for all investors – and this is especially the case where the arrangement is highly complex. Ideally, investment products that are covered by a product ruling from the Tax Office will provide certainty about the most pertinent tax treatment.
Depending on the investment, possible tax outcomes, which depend upon the relevant product and its features, include:
The investment is subject to capital gains tax (CGT) – interest may be included in the cost base of the investment and, as a result, the interest incurred cannot be deducted. In this case, the interest will reduce any capital gain that arises when the investment matures.
The investment is subject to both CGT and income tax under the ordinary rules. Dividends, distributions, coupons or any other income received during the life of the investment are subject to income tax under the ordinary rules, and any gain at maturity is subject to CGT. Deductions for interest or borrowing expenses may be limited to the amount of income received each year, especially where it can be shown that an investor could not reasonably expect to receive income (over the life of their investment) that exceeds the expenses incurred.
An investment in a longer-term financial product that involves a profit-making scheme should be accounted for at maturity, on a net basis, as a profit-making scheme or undertaking. Investors in such products do not account for amounts that are received or paid during the life of their investment – instead, these amounts are netted off against one another when the investment ends. If amounts received are greater than amounts paid, then this amount will be reported as assessable income and increase an investor’s taxable income. If amounts received are less than amounts paid, then this amount can be deducted on the investor’s tax return.
An investment that generates income in excess of outgoings, or is reasonably expected to do so, means that interest and borrowing costs are fully deductible on revenue account in the relevant income year.
Rental property — some costs are against income, some against capital
Some typical examples can be found with costs incurred for rental properties. If you take out a loan to buy a rental property, interest charged on that loan is generally available as a deduction where the property is rented to an unrelated third party. Also, interest charged on borrowings made to buy depreciating assets, or for many repairs, are generally able to be claimed.
Note that the Tax Office specifies that these deductions are only available for a property that is rented — however the wording of the tax law also allows an investor to make such claims where the property is “available for rental”. In other words, as long as the property is listed or advertised as being vacant and available for occupation, the interest charges on any loans taken out for that property can be claimed. Be mindful that where a property is “available for rental” for large periods of time a risk that the Tax Office will view it as not actually “available” may raise the danger of having the deduction invalidated.
Regular management fees or commissions paid to a property agent or real estate agent for managing, inspecting or collecting rent on your behalf are also generally claimable. However a rental property owner is not eligible to claim commissions paid to someone they engage to find a suitable rental property to buy, nor for the sale of a property they already own. These costs usually form part of the cost base of your property for CGT purposes, but you will need to confirm with our office as this may depend upon circumstances.
Certain expenditure for repairs made to the property may be deductible, but they must relate directly to wear and tear or other damage that occurred as a result of your renting it out. However, the following expenses are capital in nature and are not deductible:
- replacement of an entire structure or intrinsic item of the property (such as a fence or bungalow, a stove, kitchen cupboards or fridge)
- renovations that are actual improvements, extensions or works that are alterations to the existing building, and
- repairs that remedy defects, damage or deterioration that existed at the time you bought the property.
There may also be scope to make capital works deductions for some of the above repair or replacement works.
Most legal expenses are deemed to be of a capital nature, and are therefore not deductible (such as the legal costs involved with buying or selling a property). However one legal expense that can be claimed is the cost of evicting a non-paying tenant. For more on deductions for investments, check with this office.