Converting Your Castle

By Roelof van der Merwe, Pitcher Partners

Deductibility of rental expenses and the main residence exemption

You bought your home about a decade ago, and like the Kerrigans of the movie The Castle, have always regarded your home as, for lack of a better word a castle.

That is until now. Because you are going overseas for 5 years, you are thinking of moving out of the castle that you have lived in ever since you first bought it, and renting out the whole house (including the newly built pool room) to prospective tenants.

What are the tax implications of such a decision? What are your options?

Deductibility of rental expenses

As a general rule, expenses incurred in deriving rental income from a rental property will be deductible for tax purposes. Whether the deduction is available immediately or spread over a number of years will be determined by the type of expenses incurred.

For example, interest on loans outstanding on the rental property, the cost of advertising for tenants, lease document expenses (e.g. preparation, registration and stamp duty costs), repairs and maintenance, and council rates will be deductible immediately.

On the other hand, borrowing expenses incurred for example loan establishment fees, mortgage broker fees, and lender's mortgage insurance will be spread over the lesser of 5 years or the term of the loan if such expenses are more than $100.

In addition to being able to claim a deduction for the decline in value of the stove, fridge, pool table and any other depreciating assets, you are also entitled to claim a deduction over time for the capital works, being the pool room that you have added, and any residual capital works cost on the construction of the original house.

The deduction for the above will be spread, either over the effective lives of the depreciating assets, or depending on the type of construction of the capital works and when construction started - over either 40 or 25 years.

Remember that no deductions are available for costs that are of a personal or domestic nature.

Availability of the main residence exemption

When working out whether any capital gain on the sale of your main residence is exempt from tax, the period the house was not used as your main residence - but for income-producing purposes will be ignored, provided you start treating the house as your main residence again within 6 years of the start of the income-producing period and do not use any other property as your main residence during this time.

This means that you will eventually be able to sell your castle CGT-free if you started treating the house as your main residence again when you returned from overseas after 5 years.

Straight to the pool room

Although it is not necessary to lodge written records of income and expenses relating to your rental properties with the Tax Office, it is recommended that you keep those records for 5 years from when you lodged your tax return.

For further information on the tax consequences and opportunities available in regards to investment properties or any other tax related matter, please contact Roelof van der Merwe on (03) 8610 5000.

DISCLAIMER:Pitcher Partners is an association of independent firms. This article is intended to provide a general summary only and should not be relied on as a substitute for professional advice.