Investors Beware of the ATO

nospam@example.com (Dr Peach) — Mon, 09 Jun 2008 16:39:00 +1000

Property investment is one way to reduce assessable income through the range of tax deductions available to landlords. This year the ATO has flagged landlords among those it will be paying closer attention to at tax time.

Each year the Australian Taxation Offices announces a number of areas that they will be paying particular attention to at tax time. Included in their list for this year are investors, including investors with rental properties. The ATO tells us the reasons for their focus include the large number of new investors (the number of Australian tax payers owning rental properties has grown by 100,000 in the past 2 years to 1.6million) and the wide range of common mistakes made on claims.

What is the ATO looking for?

The ATO uses sophisticated software that identifies property investment claims that potentially contain patterns which suggest mistakes or deliberate deceptions in the tax returns. Tax payers identified in this process are then targeted for some form of follow up or audit. The characteristics of tax payer claims the ATO identifies as containing mistakes include:

unusually high claims for rental deductions
low rental income in relation to rental deductions
high claims for interest expenses, and
high claims for borrowing expenses.

The ATO lists some of the most common mistakes property investors make as:

Claiming deductions for rental properties not genuinely available for rent.
Not apportioning expense claims where the property is only available for rent part of the year, such as a holiday home.
Overstating interest claims on loans taken out to purchase, renovate or maintain a rental property.
Claiming the full cost of a visit to inspect a property when it is combined with a private purpose, like a holiday.

Some tips

If you are looking for some deductions before the end of the financial year, at this stage you may be limited to repairs and maintenance, prepaid interest or insurance or body corporate charges.

Ensure that you differentiate between repairs & maintenance and construction & improvement costs. Repairs and maintenance can be claimed as a deduction in the year incurred, construction and improvement costs are classified as capital expenditure and depreciation expenses may be claimed over time. For example, replacing an entire fence would probably be considered to be capital expenditure, where as repairing a damaged section would be classified as repairs and maintenance.

Ensure the property you are claiming deductions for is a rental property – not your weekender. If you do use the property for some of the year and rent in out for the rest of the year, revenue and expenses must be apportioned between the two uses appropriately.

Make sure that interest on your property loan has been claimed correctly; e.g. if you have a loan that is for both personal and investment use, interest must be apportioned (or talk to Peach about restructuring your loan to make things simpler!).

The ATO plans to write to new entrants to the property market with some information on the dos and don’ts of investment property deductions to let them know where to obtain more information. The ATO also publishes a booklet called Rental properties providing a guide to tax obligations for property investors. The publication can be accessed through the ATO website at: http://www.ato.gov.au.

More reasons to fix and to accelerate your deductions (with interest in advance) It's still a few months till the end of the financial year, but now is the time to start thinking about it. Each year

nospam@example.com (Dr Peach) — Thu, 09 Mar 2006 16:59:00 +1100

It's still a few
months till the end of the financial year, but now is the time to start thinking about
it. Each year there's a big rush of
applications and lenders often close their books a few weeks before the end of
June to get all the work done.

You should consider the interest in advance option each year, for its
unique tax advantages. By paying next year's interest early you can claim the
deductions one year early too.

This year interest in advance (IOA) offers unusual value for two special reasons.

1. Taxes are falling in July this year. So by paying in advance, you maximise your
interest deductions against higher tax rates and minimise it when tax is
lower. Many of those earning over
$63,000 per year are likely to gain additional benefits by maximising this
year's tax deductions, though individual circumstances will differ.

2. IOA loans are on a fixed rate. And as previously discussed, fixed rates are
unusually low given that the Reserve Bank's bias remains to raise rates. And as an economic consultant I receive lots
of e-mails each week outlining various economy watchers' views on rates. I attach an email I received from Rory
Robertson, Macquarie Bank's Interest rate strategist, where he outlines his
reasons for changing his mind on rates (arguing now that they're headed up). And
this was before very strong employment news came in, which would have
strengthened his arguments for a rate rise.

So paying interest in advance before June 30 this year is effectively
killing two birds with one stone. As
usual we've built a special calculator
to cut through the complexities and given you an indicative snapshot of what
it's worth to you.

Give us a ring
and we'll send you a full no-obligation report
outlining the indicative savings you can expect (if any) with
IOA.

How it works:

If you've paid interest monthly in arrears this year and now pay all
of next year's interest in advance before June 30, 2006, then you will in most
normal circumstances effectively claim two years' deductions in one
year.*

You can keep doing this in future years - instead of claiming two
years' interest this year and no interest next year, you can pull forward
interest payments again next year and each year after that. The total amount of
tax refunds will generally stay the same but you'll get them sooner. In effect,
it's a free loan from the government. And the "loan" from the government can
stretch out a long time.

Paying interest in advance can be particularly advantageous if the
tax rate you'll pay next year is lower than your rate now. As explained, tax cuts are likely to make
this the case if you earn over $63,000, but it may also be the case if you think
you're taxable income will fall next year - if you're going on a break, going
part time, having a child or whatever.

You might also be able to use the year your interest payments are
minimised for an "interest pause" in case you need some breathing space in the
event of an unexpected drop in income or change of personal
circumstances.

So, paying interest in advance could effectively save you thousands.

Downsides

Before we look at some examples, there are downsides that should be
considered.

You'll pay your interest earlier, so you incur your expenses as well
as get the benefits of tax deductions sooner, although generally your free kick
from the tax office can be organised fairly quickly after the financial year,
with your refund put into your mortgage.

Also fixing lowers risk, but risk isn't all bad. There's upside risk
and downside risk. It's possible you'll fix for the next year only to find rates
actually fall.

I think that a drop in rates is somewhere between unlikely and very
unlikely in the next financial year, and most economists think that any move in
rates will again be up rather than down, but none of us have crystal balls.

How to Proceed

Contact us right away, so that we can provide you with some
calculations and some ideas. We've been scanning the market for the most
competitive interest in advance loans, so you can pick our brains. And if you
refinance your loan through Peach, you can pick our pockets too.

Our normal rebates still apply. That's $1,000 or more back to you for
most many loans over $300,000 and generous rebates for loans from $150,000 -
unless you got a loan from us in the last three years in which case reduced or
zero rebates may apply.

Example: Susan

Here's an example of a hypothetical property investor, Susan, who is
thinking about paying interest in advance. She currently has a loan with a balance of about $350,000 and variable
interest rate of 6.60%. Susan is
considering switching to a 3 year fixed rate IOA loan with a rate of 6.45%.

Susan's expected income 2005-06*	$85,000
Susan's expected income 2006-07*	$85,000
Loan balance	$350,000
IOA interest rate	6.45%
Variable rate	6.60%
* before interest deduction

If Susan chooses the interest in advance (IOA) option and claims the
interest this financial year then her marginal tax rate for the year will fall
from 42% to 30%. (ignoring the Medicare levy of 1.5%) Also, as the IOA interest
rate is slightly lower than the variable rate, if she chooses the IOA option she
will be required to pay less interest than if she pays next financial year. Choosing the interest in advance (IOA) option
has two additional effects which work against each other to roughly even each
other out.

Money has a time value - a dollar today is worth more than a dollar in one year's time
(because it earns interest). Hence a tax
deduction this year is worth more to Susan than a tax deduction next year, as
any refund could be reinvested now. Likewise if Susan pays next year's interest now it will cost her more
than the same interest payment in one year's time, as she could have used the
cash put towards the interest to invest in some other income producing
investment. In this example the net
effect leaves Susan with over $1,000 more in her pocket than if she chooses to
remain on her current variable rate
loan.

Interest reduction due to lower IOA rate	$525
Reduction in tax due to interest claim in 2005-06	$675
Time value of early tax deduction	$663
Time value of early interest payment	($805)
Net saving from choosing IOA option	$1,058

If Susan is contemplating taking some time off from work
next year the effect would be amplified. Let's say she expects her income to drop around 20% next year to about
$68,000. If she chooses the IOA option
this year her marginal tax rate will still drop from 42% to 30%. Due to next year's reduction in tax rates, in
2006-07 her marginal tax rate will fall to 30% regardless of whether or not she
pays interest during the year. In these
circumstances, choosing an IOA
option will leave Susan with nearly $3,000 extra in her pocket.

Interest reduction due to lower IOA rate	$525
Reduction in tax due to interest claim in 2005-06	$2,475
Time value of early tax deduction	$663
Time value of early interest payment	($805)
Net saving from choosing IOA option	$2,858

~ Newsletters - Taxation

Investors Beware of the ATO

More reasons to fix and to accelerate your deductions (with interest in advance) It's still a few months till the end of the financial year, but now is the time to start thinking about it. Each year