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Tax Deductions room by room

In the current economic climate, more and more home owners are renting out rooms within their house to generate extra cash. This strategy can be quite lucrative, especially when considering the extra tax deductions that become available. Even when family members pay rent, by declaring the rental income in a tax return, a portion of the expenses and depreciation may be claimed as a deduction. BMT Tax Depreciation are dedicated to helping home owners maximise their property depreciation deductions and improving their cash return.

The Australian Taxation Office (ATO) has a preferred method of calculating the proportion of expenses that can be claimed as a deduction under Taxation Ruling Number IT 2167. This ruling sets out the ATO’s general approach of apportionment based upon floor areas. The ruling states that it is appropriate to add the floor area which the tenant has sole occupancy of to 50% of the general living area the tenant shares equally with the owner/occupier. It is necessary to only include general living areas the tenant has access to.

A portion of relevant property deductions can be claimed by the owner including property depreciation; which is a deduction available for the wear and tear on the fixtures, fittings and structure of a building. A portion of other expenses such as insurance, rates and the interest payments made on the mortgage of a property may also be claimed.

The following example is based on a 10 year old, 4 bedroom house with a purchase price of $450,000 and a mortgage of $360,000. It is assumed the property has 2 bedrooms generating income for the owner at $100 per week per room and that the tenants use approximately 50% of the living area.

1.Income on 2 rooms & half of living areas -
Rent per room $100
Rent per week (2 rooms) $200
Number of weeks $52
Total Annual Income $10,400
2.Expenses/Deductions -including property depreciation, interest, rates and maintenance
Estimated property depreciation $8500
Interest on mortgage $25,000
Rates, maintenance & incidentals $6000
Total Expenses $39,500
50% of Total Expenses $19,750

In this example, an owner could expect the average depreciation over the first five years to be around $8,500 per year. If the property was completely rented, the total deductions for the year would be $39,500. However, as half of the property is producing income, the actual deduction available to the owner will be $19,750.

It is important to remember that normal expenses and depreciation always exist; the difference here is that approximately half of these deductions are now claimable because part of the property is producing assessable income.

The cash flow results for this scenario are as follows:

Financial Year 1

Total income at $200 per week for 2 rooms & living areas:

50% of total book loss -$19,750
(including interest, rates, maintenance and depreciation)
Taxation loss (income - expenses) $9,350

Tax return calculates at the Australian tax rate of 37%

Total Annual Income $13,860

By claiming 50% of the depreciation and other expenses, the extra tax deductions improve the owner’s cash flow by $3,460 in the first financial year.

When renting a room out in an owner occupied house, it is important to obtain a property depreciation report from a specialist Quantity Surveyor like BMT Tax Depreciation. This will ensure the tax deductions are maximised. It is also important to discuss the options available with an accountant. When a home is changed into a partial investment property, some Capital Gains Tax (CGT) may be triggered if the property is later sold. However, there are scenarios which may reduce or create a total CGT exemption depending on the property’s first use, how long the property was lived in, how long it is income producing and if the owner purchases another home.
Contact BMT today to discuss any property scenario.

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Disclaimer: The case study estimates shown are based on the diminishing value method of depreciation and are provided as an approximate guide, for example purposes only. BMT Tax Depreciation is not liable for any misinterpretation from this example.