Changes to the deduction for travel to inspect rental properties
One of the changes announced in the 2017 federal budget removed the ability for individual taxpayers to claim a deduction for travel to their residential rental property. This measure applies to any travel costs incurred by a taxpayer on or after 1 July 2017.
Whilst this measure is clearly aimed at closing a perceived loophole that would allow a deduction for a taxpayer to travel to “inspect” their holiday home on the Gold Coast or in Dunsborough (which would conveniently be unavailable for rent that weekend), there are potentially unintended consequences for other taxpayers.
For example, an individual may seek to maximise their investment in the property by undertaking all aspects of management of the property themselves, including attending to repairs and maintenance, property inspections and in some cases, collection of rent. Under the current law, the cost of travelling to attend to these activities would not be deductible.
However, if the individual engages a property manager to manage these activities on their behalf, that cost is deductible. One wonders whether the Property Council of Australia raised a cheeky glass to the government following the budget announcement.
The rules are also likely to impact individuals who advertise their property on short-stay, sharing economy platforms such as Airbnb. Where an individual attends to laundry and restocking consumables themselves, the travel to attend to this will no longer be deductible. Again, if this role is outsourced to a third party, those costs will be deductible. Adding that cost to other costs of using a sharing economy platform may lead to people choosing to take their properties off the short-term market. This may place additional strain on accommodation infrastructure in capital cities and tourist destinations.
Generally speaking, where costs in respect of owning a property are not deductible, they can be added to the cost base of the property for capital gains tax purposes, meaning a deduction is effectively allowed when the property is sold. For example, rates and taxes on a holiday home that is not being used for rental purposes, can be added to the cost base of the property and reduce any capital gain on sale.
However, these new measures not only disallow an immediate deduction for travel by individuals that is related to their residential rental property, it also prevents them from adding the cost to the cost base.
The rules will not impact individual investors who own commercial rental properties, and travel costs relating to those properties will continue to be deductible. This would mean that an investor with a commercial rental property in the Gold Coast or Dunsborough, may be entitled to a deduction for a portion of travel costs to inspect the property, even where the inspection is connected with a holiday to the region. One wonders if enquiries for properties in light industrial areas in popular tourist destinations have increased since the announcement in the 2017 federal budget.
The rules will also not impact residential property investors who are carrying on a business of maintaining rental properties, but whether an individual taxpayer’s activities in respect of their rental property would be sufficient to be the carrying on of a business will always be a matter of fact and degree.
There is little by way of planning that a rental property investor can do to minimise the impact of this particular change. Costs of engaging a property manager to undertake the travel for inspection and maintenance, along with other property management duties, will be deductible, but this may reduce the rental yield of properties where individuals were undertaking those activities themselves prior to 1 July 2017.
Changes to deductions for second hand plant and equipment
The other major change for residential rental property investors was the removal of depreciation deductions for second hand plant and equipment used in residential rental properties. The rules apply to assets acquired on or after 7:30pm on 9 May 2017, but the denial of deductions for second hand assets commenced from 1 July 2017.
The measure appears to be aimed predominantly at stopping individuals from claiming excessive deductions for second hand assets used in rental properties by “refreshing” the value or effective life of previously used depreciating assets used or installed in those properties.
For example, prior to 9 May 2017 an individual could buy a residential rental property that had installed assets including an air conditioning system, solar panels, an oven and a dishwasher. The purchase contract would not allocate value specifically to these assets, but the individual could engage a quantity surveyor or other independent valuer to determine the value of these assets, and then use that value to claim a deduction for the depreciation of the assets.
However, if the same property with the same assets was acquired on or after 10 May 2017, no deduction would be available for the assets acquired with the property.
The rules also apply where an individual acquires a property as their main residence and acquires plant and equipment for their personal use in the property. Whilst no deduction would be allowed for the personal use, if the individual moves out and starts renting out the property, or makes the property available for short-term stays via a sharing economy platform, they would not be entitled to a deduction for depreciation on the assets they acquired.
The rules not only apply to assets acquired with a property, they extend to deny deductions for any second hand or used asset acquired by a tax payer for use in a rental property. As with the above changes to deductions for travel, individuals looking at saving money by buying second hand goods for a rental property will be adversely affected. One wonders if the shareholders of Harvey Norman and JB Hi-Fi were as happy with the announcement as the quantity surveyors were upset with it.
The rule changes do not impact deductions for second hand structural improvements (e.g. patios, fencing, retaining walls, paving), meaning individuals buying a residential property can still maximise their rental property deductions by engaging a quantity surveyor to determine the value of structural improvements.
And similar to the changes to travel deductions, the rules do not apply to owners of commercial rental properties, or individuals carrying on a business of running residential rental properties.
Individuals acquiring rental properties with second hand assets should still make the effort to determine the value of the assets acquired, as the new rules still require the calculation of capital gains or losses on the sale of second hand depreciating assets. This may occur when the property is sold inclusive of the second hand assets, or it may occur when a second hand asset is scrapped or replaced with a new asset.
Conclusion
The above changes were touted by the government as part of a package to make housing more affordable. The reality is that the changes appeared to be aimed at closing deduction loopholes being exploited by some tax payers, but have had unintended adverse consequences for individuals seeking to maximise rental property yields. It’s likely to be too early to determine the impact of the changes on housing affordability, but at 30 June 2018, individuals who have undertaken property management themselves, or acquiring second hand assets to furnish their rental properties will certainly feel the impact on their hip pocket.
Catherine Davidson, senior analyst, RSM
