There is a saying in the USA that you do not mess with the IRS.
For Aussies, the same thing could be said about the ATO.
In The Weekend Australian (January 26-27, 2019 @ page 2), there is an article by Michael Roddan titled: ATO sets sights on holiday rent ‘loss’
Here is a summary of the key points which may be of interest to those of you who own rental units.
How big is the rent loss pie?
Rental property losses are calculated at more than $20 billion each year. These losses can be offset against an income-tax bill under the government’s negative gearing laws.
Significantly, the holiday rental market is almost entirely made up of owners who would negatively gear.
In the 2018 federal budget, the ATO received $130 million to increase its surveillance of personal tax deductions over the next four years, which will focus on rental losses.
$130 Million on Surveillance: Sounds a bit more sophisticated than ‘just having a look’.
The ATO has found that incorrectly claimed rental property deductions are one of the major contributors to the annual $9 billion tax gap – the difference between what the ATO should collect and what it does collect.
The ATO now claims it will claw back close to $1 billion of these wrongly claimed rental deductions over the next four years.
Is this all huff… with no puff?
Perhaps yes. It could be just a big bluff.
But when most government agencies are experiencing ever-increasing pressure to deliver more effective outcomes with fewer staff, it may be safer to assume the ATO will not be committing valuable resources to a four-year program just in case they stumble onto something big.
An ATO spokesman is reported to have claimed “Over the past year we have expanded our focus on incorrectly claimed rental deductions.” and “We are aware some holiday home owners are doing the wrong thing and claiming deductions they are not entitled to.”
We read this as bureaucratic code for:
“We have done our research. We know which data bases to crossmatch against tax records…we know what to look for…we know whom to look at. We are ready to go.’’
What are they targeting?
The big deductions for most negatively-geared rental units include:
- Utilities e.g. water and energy
- Body corporate levies
- Interest payments on mortgages
(Another traditional big-ticket item – travel expenses for inspections / repairs etc – was recently deleted as an allowable deduction.)
The ATO could target any of these deductions as a separate risk if it were simply looking at rental losses in general.
It appears that for the holiday rental market, the ATO will focus on correct apportionment of these overall deductions on a time basis ie only allowing deductions for the proportion of the year when the property was actually available for rent. For example, if the property is only available for rent for half of the year, you can only claim half of the annual expenses.
What are the risk indicators?
- No Rental Income: Not available for rent at any time e.g. permanent ‘lock-up’ units.
- Low Rental Income: Long-term nominal rents involving family members and/or friends who “get it really really cheap because they look after the property really really good’’.
- Patchy Rental Income: Generally available for rent, but unavailable for certain periods e.g. the owner uses it for private purposes either during the peak or off-peak seasons, or on the weekends etc. This would include the property being made available to family members and/or friends for free.
- Advertised Sky-High Rents: Very little likelihood it would ever be rented.
- Nil Advertisement Costs: Advertisement by ‘word-of-mouth only’ may mean there is little likelihood of it ever being rented.
Why is the ATO telling us what it is going to target?
The appearance of headline articles in national media outlets – like The Weekend Australian – before the enforcement audits get underway normally means it is part of a traditional compliance strategy employed by the ATO. This strategy is designed to encourage voluntary disclosure by the taxpayer before any direct audit contact from the ATO.
If the ATO has to make the first direct audit contact with a taxpayer, penalties of as much as 75 per cent can be imposed on top of the wrongly claimed deductions.
If you make the first contact, however, this can allow the ATO to substantially reduce the penalties. It may still be a bitter pill to swallow, but it saves you money and it saves them time. It is our understanding the ATO prefers this voluntary disclosure approach; they see it as a WIN / WIN for both sides.
Hence their pre-emptive media releases.
What can you do?
If you fit into the target group and have any concerns about your rental property claims, the UOAQ would suggest you consult your taxation adviser as a matter of priority. Better safe than sorry.