How is rental income taxed?

Aussies love investing in property. According to ATO data, around 2.2 million of us earned income from an investment property in the 2021-22 financial year. Of those, nearly 60% reported making a profit. 

Do you own an investment property or are you thinking about buying one? You might be wondering if rental income will affect your tax bill (or refund). The short answer: it likely will.

Here's what you need to know about how rental income is taxed.

How is rental income taxed?

A common myth is that rental income is taxed at a different rate - but that's not the case.

"Rental income is taxed at the same rates as any other income source," H&R Block director of tax communications Mark Chapman told Your Mortgage.

"So, it is taxed at the taxpayers marginal rate, as the top slice of their income, at a rate of either 19%, 30%, 37% or 45%, depending on how much other income they have."

"When you own a property and rent it out, the rental income which you earn is taxable [and] there is no way that you can receive rental income and not include it on your tax return."

Australian income tax brackets, as of financial year 2024-25, are as follows:

Income	Tax rate
$0 - $18,200	Nil (under the tax-free threshold)
$18,201 - $45,000	16c per $1
$45,001 - $135,000	30c per $1
$135,001 - $190,000	37c per $1
$190,001 and over	45c per $1

^{The above tax rates do not include the Medicare levy.}

Another common misconception is that moving into a higher tax bracket means paying a higher tax rate on all your income. In reality, only the portion of your income that falls into the higher bracket is taxed at the new rate. For example, whether you earn $45,000 or $1 million in a given year, you'll still only pay a maximum of 16 cents per dollar on the first $45,000 you earn.

If you own a rental property alongside someone else – say, a partner, family member, or friend – you'll report a share of the rental income generated equal to your ownership. So, if you have a 20% stake, you'll have to pay tax on 20% of the rental income realised in a given tax year.

Where tax on rental income majorly differs from that on wages or income from other sources is in what an investor can deduct.

What are investment property tax deductions?

Tax deductions are a mainstay of the Australian taxation landscape. A deduction is an expense you can detract from your taxable income, reducing the amount of tax you owe.

In simple terms, deductions lower your assessable income, meaning you only pay tax on what's left after eligible expenses are accounted for. When it comes to rental income, deductions can be numerous and substantial.

Some of the things you can deduct from your taxable income as a property investor include:

• Interest on an investment mortgage

• Council rates and land tax

• Advertising costs

• Body corp fees

• Insurance

• Maintenance costs

Other, more obscure deductions noted by Mr Chapman include costs associated with advertising, cleaning at the end of tenancies, gardening, bookkeeping, bank charges from receiving rent, and even legal and debt collector bills if your tenant doesn't pay their rent.

"Always keep detailed records of all income and expenses," he said.

"If the ATO reviews or audits your tax return, you will need your supporting documentation to justify your deduction claims."

It's important to note that you can only claim deductions on expenses incurred while your investment property is rented or genuinely available for rent. Deductions can't be claimed for periods when the property is:

• Vacant and not actively listed for rent

• Used by you or someone close to you

• Or insincerely advertised for rent (for instance, if its being offered at an exorbitant price compared to the rest of the market).

Expert tip

It's common for financial institutions to offer redraw facilities against existing loans, which investors sometimes use to purchase investment properties. Such a redraw may be used for income-producing purposes, non-income-producing purposes, or a mixture of the two.

In the latter case, the interest on the loan must be apportioned between the deductible and non-deductible components, with the split reflecting the amounts borrowed for the rental property and the amount borrowed for private purposes.

Try to avoid mixing loan accounts that have both deductible and non-deductible components.

- Mark Chapman

What is depreciation on an investment property?

One of the most significant tax deductions available to property investors is depreciation. While property itself is typically an appreciating asset - meaning its overall value rises over time - many of the components within a home, such as carpets, appliances, and fixtures, depreciate - or lose value - as they wear out.

Similar to other expenses, investors can claim depreciation as a deduction over time, reducing their taxable income each financial year.

"Depreciation is generally one of the larger deductions, and it is difficult to correctly work out," Mr Chapman said. "Many homeowners miss out on potential deductions by incorrectly claiming.

"It can be worthwhile getting a quantity surveyor to quantify the depreciation claims that you are entitled to."

Depreciation is divided into two main categories:

1. Capital works deductions
   Covers the structural elements of the property, such as walls, floors, roofing, and built-in fixtures. Residential properties built after September 1987 are eligible for capital works deductions, typically claimed at 2.5% per year over 40 years.

2. Plant and equipment depreciation
   This applies to the wear and tear of a property and its assets. The depreciation rate is based on each asset's expected lifespan.

Rental tax intricacies: Positive and negative gearing

Another intricacy of tax on rental income is gearing. Gearing simply means to borrow money that you then invest.

• A positively geared property brings in more rent than it costs to hold, generating extra cash flow

• A negatively geared property costs more to own than it earns in rent, creating a loss

What is negative gearing when it comes to property investing and tax?

Negative gearing is a hot topic in finance, politics, and property investing, but what does it actually mean?

While not explicitly defined in tax law, negative gearing refers to when a property investor's expenses - including loan interest, maintenance, and other costs - exceed their rental income.

This loss can then be offset against the investor's other taxable income, such as wages or investment earnings, reducing their overall tax bill.

But you can't simply drop the rent in order to negatively gear your property.

"The rent received must be at normal market rates to be able to claim all the expenses in full," Mr Chapman said.

"If you rent at below market rent - to family or friends perhaps - you can only claim deductions up to the amount of rent charged."

Capital Gains Tax (GCT) on rental properties

While CGT doesn't impact rental income specifically, it's an important factor to consider when buying or selling an investment property.

CGT applies when you sell a property for more than you paid for it, with the profit - known as a capital gain - being added to your taxable income. Conversely, if you sell at a loss, you may be able to offset that capital loss against other capital gains.

How CGT works on investment properties:

• Taxable event: CGT is triggered when you sell your investment property. The gain is added to your income for the financial year.

• CGT discount: If you've owned the property for more than 12 months, you may be eligible for a 50% CGT discount, meaning only half the gain is taxed.

• Exemptions: Your principal place of residence (PPOR) is generally exempt from CGT, whereas investment properties typically aren't. However, an exception applies if the property was previously your PPOR, you sell it within six years of moving out, and you haven't purchased another home to live in before you sell the investment.

Example
If you buy an investment property for $500,000 and later sell it for $700,000, your capital gain is $200,000. If you've owned the property for more than 12 months, the 50% discount applies, meaning you only pay tax on $100,000 at your marginal income tax rate.

Since CGT is based on your total taxable income, selling a property in a high-income year could result in a bigger tax bill.

_{Photo by Markus Winkler on Unsplash}