Rental Income and Allowable Deductions
Rental income from an investment property is fully assessable in the year received. Against this income, a broad range of expenses directly related to producing that rental income are deductible - reducing the net assessable amount and often creating a tax loss (negative gearing).
- Deductible expenses: Interest on investment loans (the primary deduction for most investors), property management fees (typically 7–10% of rent), council rates and water rates, landlord insurance premiums, repairs and maintenance (immediate deduction - must be genuine repairs, not improvements), strata levies, accounting fees for the property, advertising for tenants, pest control, cleaning between tenancies, and land tax (where applicable).
- Repairs vs capital improvements - critical distinction: Genuine repairs (fixing a broken tap, patching a hole in the wall, replacing a broken fence section) are immediately deductible. Capital improvements (adding a new room, installing a new kitchen, building a deck) are not immediately deductible - they are added to the cost base and depreciated over time, or increase the CGT cost base. The ATO scrutinises 'repair' claims carefully - renovating an entire bathroom is not a repair, it is a capital improvement.
- Interest deductibility and loan purpose: Interest is deductible only on money borrowed for income-producing purposes. If you redraw from an investment loan to fund personal expenses, the redrawn amount's interest is NOT deductible - the loan purpose has changed. This 'contamination' is permanent and requires careful tracking. Always use a separate loan account (split loan) for personal and investment borrowing.
- Negative gearing: When total deductible expenses (including interest, depreciation, and other costs) exceed rental income, the resulting loss is deductible against other assessable income in the same year - wages, business income, other investment income. There is no cap on the amount of negative gearing loss claimable, provided the investment is held with a genuine expectation of profit.
- Prepaid expenses: Landlords can prepay certain expenses (insurance, interest on fixed-rate loans) up to 12 months in advance before 30 June and claim the deduction in the current year - accelerating the tax benefit into a high-income year.
Depreciation: Division 40 and Division 43
Depreciation is the most commonly missed and most valuable deduction for investment property owners. Two separate depreciation systems apply - one for the building structure itself, one for its contents.
- Division 43 - Capital works deduction (building structure): A deduction of 2.5% per year of the original construction cost is available for residential buildings constructed after 15 September 1987 and commercial buildings constructed after 26 February 1992. The deduction is based on construction cost - not purchase price. A property built in 1995 for $180,000 (construction cost) generates $4,500/year in capital works deductions regardless of what you paid to purchase it. These deductions reduce the cost base - increasing the capital gain on eventual sale.
- Division 40 - Plant and equipment (depreciable assets): Individual assets within the property are depreciated over their effective life as determined by the ATO - carpets (8–10 years), dishwashers (10 years), hot water systems (12 years), air conditioners (10–15 years). Each item generates an annual depreciation deduction based on diminishing value or prime cost method.
- Second-hand plant and equipment restriction: For properties purchased after 9 May 2017, plant and equipment items that were previously used by another owner (in an established property) CANNOT be depreciated by the new investor. Only new items installed by the new owner after settlement are depreciable. This restriction does not apply to: new builds, commercial properties, or properties substantially renovated before purchase.
- Quantity surveyor's tax depreciation schedule: An AIQS-qualified quantity surveyor inspects the property and prepares a report identifying all depreciable items, their values, and annual deduction amounts. Cost: $600–$900 one-off. The schedule generates deductions for years - typically $5,000–$20,000+ in year one for a newer property. The ATO requires a quantity surveyor's report to claim Division 43 deductions where the construction cost is not known - self-estimation is not accepted.
- Low-value pooling: Plant and equipment items costing less than $1,000 (or with a written-down value below $1,000) can be pooled and depreciated together at 37.5% diminishing value - accelerating deductions for low-value items.
Land Tax and Stamp Duty by State
Land tax is levied by state and territory governments on investment land holdings above a threshold. It is a significant ongoing cost of investment property ownership that is fully deductible against rental income. Rates and thresholds vary substantially by state - understanding your state's regime is essential.
- NSW: General threshold $1,075,000 (2024-25). Land value above threshold taxed at $100 + 1.6% up to $3,239,000, then 2.0% above. No land tax on primary residence.
- Victoria: General threshold $300,000 (significantly lower than other states). 0.2%–2.55% depending on land value. Premium threshold at $3,000,000 - higher rate applies. Trust surcharge of 0.5% applies to discretionary trust landholdings above $250,000.
- Queensland: General threshold $600,000. Rate: 1 cent per dollar above threshold to $1M, then 1.65 cents per dollar above $1M to $3M, then 2.25 cents. Higher rates for foreign owners.
- South Australia: Threshold $842,000. Rate: $1,452 + 1.571% on value above $842,000 up to $1,241,000, then higher rates above. No land tax on primary residence.
- Western Australia: Threshold $300,000. Rate: 0.25%–2.67% depending on value. Metropolitan and country different rates.
- Tasmania: Threshold $100,000. Rate: 0.55%–1.5%. Low threshold makes land tax payable on most investment properties.
- ACT: No separate land tax - replaced by rates-based system. Investor properties subject to higher general rates.
- Land tax planning: Holding investment properties in multiple ownership entities (individual name, trust, company) may result in aggregation of landholdings for land tax purposes in some states - particularly Victoria. Check aggregation rules before structuring property purchases across multiple entities.
Capital Gains Tax: Discount, 6-Year Rule and Withholding
When an investment property is sold, a capital gain (or loss) arises. The tax treatment depends on the holding period, whether the property was ever your main residence, and whether the owner is an Australian resident for tax purposes.
- 50% CGT discount: Capital gains on investment properties held for more than 12 months by individuals or trusts qualify for the 50% CGT discount - only half the net gain is assessable. Companies receive no discount. The 12-month clock starts from the contract date (settlement date is not used). Important: the discount reduces the gain AFTER applying any capital losses from that year or prior years.
- Cost base - what is included: The cost base of a property includes: purchase price, stamp duty, legal/conveyancing fees at purchase, building and pest inspection, agent's commission on sale, legal fees on sale, capital improvement costs (additions, renovations), and costs of obtaining finance (mortgage registration, loan establishment fees). Depreciation deductions claimed under Division 43 REDUCE the cost base - this is the 'depreciation recapture' that increases the CGT on sale.
- Main residence 6-year rule: If you lived in the property as your principal place of residence before renting it out, you can elect to treat it as your main residence for up to 6 years while renting - exempting the property from CGT for that period. The 6-year period resets every time you move back in. You cannot nominate another property as your main residence during this period. You can only have one main residence at a time (except for the standard 6-month overlap period when changing residences).
- Partial main residence exemption: If a property was your main residence for part of the ownership period and an investment for the rest, a partial exemption applies based on the proportion of time it was your main residence. The calculation uses the number of days as main residence ÷ total days owned × total gain - but the cost base is stepped up to market value at the date of first rental, if you move out first (reducing the taxable gain).
- Foreign resident CGT withholding: When a non-resident of Australia sells Australian real property worth $750,000 or more, the buyer must withhold 12.5% of the purchase price and remit it to the ATO - even before the seller lodges their tax return. Australian residents selling property over $750,000 should obtain a clearance certificate from the ATO (application online, typically issued within 1–28 days) to confirm residency and avoid withholding. Without a clearance certificate, the buyer is legally required to withhold 12.5% at settlement.
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