Rental income and tax: What Australian investors need to know

Passive income has been a buzzword in recent years. It means income that one can earn without lifting a finger. And one of Australia’s favourite sources of passive income is property. 

When an Aussie buys an investment property, they can rent it out and pocket that rent as income. But, while they didn’t slog away for hours to get that cash, the tax office will still want its cut. 

That’s right. Rental income is taxable income. Though, investment properties can also provide tax deductions … and they can see an investor facing capital gains tax, too. Oh my. 

If your head is swimming already, you’ve come to the right place. InfoChoice is here to break down all property investors need to know when it comes to tax time. 

Read on to learn about how rental income is taxed, what property investors can claim as deductions, how negative gearing works, and what the future holds for Australian taxation.

How is rental income taxed?

Rental income is taxed just like income earned through employment, a business, or another investment vehicle. That means you need to declare your rental income and related deductions (more on this soon) in your tax return.

How much tax you pay on your rental income will depend on your marginal tax rate which, as of financial year 2023-2024, will be one of these:

 So, if you earn $50,000 through your employment and $20,000 in rental income this financial year, your total taxable income would be $70,000. If you didn’t make any deductions on that figure, you would pay $13,217 in tax ($5,092 + 32.5 cents for every dollar over $45,000 ($25,000 * $0.325 = $8,125)). 

If you own a rental property in partnership with another person, you need to declare a portion of any rental income based on your ownership of the property. For instance, if you own 50% of an investment property alongside a friend, you must declare 50% of any rental income realised from that property in a given financial year.

That’s the case even if your rental property is only available for short term stays (like an Airbnb), if you’re only renting out part of your property (say, a room or a garage), or if you’re charging your mate to crash on your couch (even if it's only $50 a week). 

You also need to declare any payments you receive through holding your investment property. Such payments might include a portion of a tenant’s bond that you keep to repair damage to the property or an insurance payout.

Deducting expenses related to rental income

Just like how you might claim the cost of a new pair of work boots at tax time, thereby reducing your taxable income by their value, you can also deduct expenses related to your investment property. However, there are limits as to what you can claim and how you can claim it. 

For instance, you can’t claim expenses related to the purchase or sale of an investment property. Though, you do need to keep records of such expenses for the purpose of capital gains tax (we delve into capital gains tax in a moment). 

Immediately claimable expenses

Immediately claimable expenses for those renting out a property include:

• Interest paid on an investment home loan

• Council rates

• Advertising costs

• Body corporate fees

• Land tax

• Property management fees

• Repairs and maintenance costs

Expenses that can be claimed over several years

On the other hand, some costs must be spread out over a number of years. Take borrowing expenses for example. If costs such as lenders mortgage insurance (LMI), loan establishment fees, and stamp duty charged on a mortgage total more than $100, related deductions should be spread over a five year period or over the life of a loan, whichever is less.

Other costs that can be claimed over a number of years include renovations or improvements made on a property. The ATO considers most improvements to be ‘capital works’, which can generally be claimed at a rate of deduction of 2.5% or 4% each year for 40 years or 25 years respectively. 

Depreciating assets

Finally, there are some expenses related to investment properties for which an owner can claim a deduction for a decline in value – called depreciation. 

When it comes to investment properties, depreciating assets are things that are separate from the property, aren’t permanent, and can be replaced within a relatively short period. Examples include dishwashers, curtains, and flooring. This might also be called property plant & equipment.

What to consider when making deductions

When claiming expenses, it’s important to consider how available a property was during the year and how much of the property (or its availability) was taken up for personal use.

You can’t simply buy an investment property and claim expenses related to it without renting it out. It must be deemed ‘genuinely available for rent’. That means it must be tenanted or properly advertised as available at a reasonable price with reasonable rental terms. 

Further, if you rent out one room in your two-bedroom apartment and live in the other, you might only be able to claim 50% of incurred expenses related to your property. Or, if you stay in your beach house for one month each year and offer it up for short stays the rest of the time, you might be able to deduct 92% of your relevant expenses (as one month is equal to approximately 8% of a year). 

Whether your tax deductions work out to be more or less than your rental income in a given year will determine whether your investment property is ‘positively geared’ (earning a profit) or ‘negatively geared’ (operating at a loss). 

Negative gearing

If passive income has been an investment buzzword in recent times, negative gearing has been a political one. Negative gearing is essentially the mechanism of declaring costs from a loss-making rental property as a tax deduction.

If you’ve found that the costs involved with your investment property outweigh the rental income you earn, you might be able to reduce your other taxable income by the value of the losses you realise. 

Ultimately, however, a negatively geared property is still a loss making endeavour. The major benefit of negative gearing is to minimise investors' losses while they wait to realise capital gains, not necessarily to provide overarching, long-term benefits.

Further, being negatively geared generally means you’re cashflow negative from week-to-week. This means you will need to be able to afford this shortfall until tax time rolls around and you can claim the expenses to offset it against your income.

Capital gains tax: Investment property edition

The ATO isn’t only interested in rental income you earn while you hold your investment property. It will also want to know about your capital gains.

A capital gain is the profit that an investor might realise if they were to sell their property for more than they paid. While it’s generally referred to as a specific tax, capital gains tax is actually reported as part of a person’s income tax. Thus, if you bought an apartment for $500,000 earlier this year and recently sold it for $550,000, you’ll have to pay income tax on an additional $50,000 come the end of this financial year.

However, if you had held the property for more than 12 months, you would have been eligible for a 50% discount on capital gains tax. Thus, your taxable income would have increased by $25,000 on the back of the sale. If you are in say the 45% top tax bracket, and hold a property for longer than 12 months, the capital gains would be taxed at 22.5%.

But there are exceptions.

If you purchased your investment property prior to September 1985, you won’t need to pay capital gains tax if you realise a profit on its sale. Though, you might end up paying capital gains tax on any improvements you made to the property after that date.

But what if you didn’t make a profit on the sale of your investment property? Well, if you made a capital loss, you can use that loss to offset any other capital gains made in the same or subsequent tax years.

Primary residence rules

Further, your main residence is also exempt from capital gains tax. However, that mightn’t be the case if you rent part of it out. Ditto for if you’re using part of the property for a business; when preparing tax statements you’ll have to estimate the percentage of the house used for rent or a business and adjust accordingly.

In addition, there is also the advent of what’s called the ‘six year CGT rule’. This enables you to be exempt from capital gains tax for up to six years at a time on a property you rent out as long as it’s considered your ‘primary residence’.

This means you can essentially treat it as an investment property and get tenants in without paying CGT for that period. You can then move back in for a period, and move back out, and start the six-year cycle again - indefinitely. Rental income will still be considered taxable income, however.

To be eligible for the six-year CGT rule, you can’t accept any other place as your primary residence for that time. The purpose of this rule is to remove the CGT burden for those with short term work offers and other responsibilities which require them to move out of their primary residence.

Changes to tax rates from 2024-25

Have you heard about ‘stage 3 tax cuts’? They’re the third and final stage of a plan to simplify Australia’s tax system first put into action in 2018, and they’re about to come into effect. 

Ultimately, they’ll see the table we included above, depicting Australia’s marginal tax rates, scrapped. Well, at least a large part of it. 

It will see the 37-cents-per-dollar tax bracket scrapped entirely and the 32.5-cents-per-dollar dropped to 30-cents-per-dollar and extended to encompass income of up to $200,000. So, come financial year 2024-2025, the table might look something like this:

If in doubt, reach out for expert help

And that’s not all, folks. Taxation can seem like a rabbit warren of ‘ifs’, ‘buts’, and ‘maybes’ and the system can easily leave a property investor feeling lost. 

If you’ve read to the bottom of this article and still feel unsure about your tax position, it might be your sign to reach out to an expert for independent advice.

Read more: Financial Planning Investing Buying a home

Brooke Cooper

Finance Journalist

Brooke Cooper joined the InfoChoice Group in 2023. She previously wrote for the Motley Fool, covering topics such as share prices, companies, and IPOs. With interests in everyday finance and wealth, Brooke is passionate about educating Aussies - especially young adults - on all things money.

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