Tax specialists say there has been an exponential increase in inquiries from cash-strapped property investors preparing for “bumper” tax deductions to soften the blow of reduced rental income from the coronavirus shutdown.

Residential and commercial investors are readying to maximise negative gearing and deductions for property expenses in the five-week lead-up to lodging their returns on July 1.

“The rate of inquiries from property investors in April has been increasing exponentially from the lows of late March,” says Nol Petrohelos, a director of BMT Tax Depreciation, which specialises in tax depreciation for residential and commercial property.

“I expect July will be a bumper period for taxpayers lodging early to get their hands on bigger-than-usual refunds,” says Mark Chapman, director of tax communications for H&R Block.

Petrohelos, whose company’s main clients are smaller investors, says there has also been a spike in tax inquiries from owners of commercial property, which had become more popular among small investors before the COVID-19 downturn.

More than 1.5 million Australian households own one investment property and another 600,000 own between two and six properties, according to investment bank Morgan Stanley.

Property investors are being hit by falling rent (which puts pressure on their capacity to repay mortgages) and reduced or lost wages. Many insurers have refused to cover any shortfall, despite pleas from the federal government for negotiated agreements between owners and renters. 

Most investors rely on rental income for 44 to 48 weeks per year to cover their loan repayments and other running costs such as council and water rates, strata levies and repairs, according to Adrian Raftery, author of 101 Ways to Save Money on Your Tax – Legally.

Land tax concessions announced by state governments typically target the top end of town and are not available for 90 per cent of smaller investors, according to buyers' agents.

Pain postponed

Repayment relief from lenders only postpones the pain for a few months.

“We believe that the strong inquiries in April from both residential and commercial property owners is because people are needing to maximise their cash return by increasing tax deductions now more than ever due to the current and potential financial strain put on landlords due to the COVID-19 crisis,” says Petrohelos.

A spokesman for the Australian Taxation Office says it understands that problems caused by COVID-19 mean some tenants in residential properties may not be able to meet their payment obligations under their lease agreement.

“If tenants are not meeting their rent payments due to COVID-19 and you continue to incur normal expenses on your rental property, you will still be able to claim these expenses in your tax return,” the spokesman says.

“Also, if you need to reduce the rental amount to enable your tenants to remain in the property, your deductions will not be reduced,” he says.

Typical expenses for a rental property include property management fees, insurance, council rates, land and water rates, interest on mortgage repayments and repairs and maintenance.if the landlord agrees to a reduction in rent, only the reduced rental needs to be declared.

But the ATO treatment of COVID-19 deductions does not apply where the rent reduction is made to simply enable a tenant to remain in the property. “This is maximising rental return in a changed rental market,” says the ATO spokesman.

Investors can continue to claim interest on the loan as a deduction if the lender defers loan repayments because of the pandemic.

“Interest accumulating on a loan is an expense the investor has incurred and is therefore deductible. Interest remains deductible on the loan even if the bank defers the repayments,” says the ATO.

In cases where net rental losses exceed all other yearly income – which might happen for retirees relying on rent for their income – the tax loss can be carried forward to future tax returns.

H&R’s Chapman cites an example of how an investor’s tax losses might more than double because of the pandemic.

Case study

Let’s say rental income for an investor is $2000 per month before COVID-19. Deductible expenses – including mortgage interest, rates, repairs, etc – were $2400 per month. So the tax loss for the year would normally be $4800 ($24,000 annual income less $28,800 deductible expenses).

If the landlord agrees to reduce the rent to $1000 per month for six months but deductible expenses stay the same, the tax loss would become $10,800 (being $18,000 annual income less $28,800 deductible expenses).

“In practice, the deductible expenses might also fall, or the landlord might look to recoup the lost rent later in the year, so the actual figures might not work out as black and white as that,” Chapman says.

“The landlord simply declares the full amount of rent received – so, if the landlord agrees to a reduction in rent, only the reduced rental needs to be declared,” he says.

“Then the normal expenses can be claimed, assuming they haven’t been waived or reduced too.”

If the landlord accepts lower payments but doesn’t actually formally reduce the rent – such that the tenant needs to pay back the underpaid rent time when things get back to normal – that rent will be taxable when it's paid.

The government has introduced specific rules for commercial investors and their relationship with tenants.

“[Commercial] landlords and tenants must negotiate in good faith to share the burden of surviving the pandemic and resuming normal business when the crisis ends,” says Neil Brennan, director of business advisory at William Buck Accountants & Advisers.

“A one-size-fits-all approach is impossible to mandate. As a result, a set of principles have been outlined to form the basis of the negotiation,” Brennan says.

These include rental waivers of at least 50 per cent for the duration of the pandemic, with this being increased to the normal monthly rent over two years post-COVID 19. The increased payments will also include a percentage of the deferred monthly rent.

“Landlords should prepare for the tax impacts of having higher monthly income during this recovery period," adds Brennan.

Original article published here on 22 April 2020.