Landlord tax deductions soar as interest rates bite property market

Soaring interest rates will push taxpayer support for the nation’s 2.4 million landlords to record levels as deductions offered for borrowing costs surge above $7 billion a quarter.

The interest bill on property investors’ mortgages has soared by 50 per cent over the first nine months of this financial year – one of the biggest jumps on record – due to the Reserve Bank’s aggressive tightening of monetary policy since May 2022.

Soaring interest rates will drive up the cost of rental deductions, hitting the federal budget bottom line.

Peter Rae

Landlords can claim a range of costs as tax deductions against the income they earn on their properties, with a leading economist noting this could help ease pressure on rents as it softened the blow from rising interest rates.

Interest on loans is the single largest deduction, accounting for almost half of the total $50 billion expected to be claimed annually by property holders.

Both landlords who negatively gear their properties, and those who make an income from their rentals, claim interest deductions.

Through the 2010s, the cost of interest deductions was flat due to the small falls in official interest rates. In 2018-19, the nation’s landlords lost a collective $3.1 billion as their costs exceeded their rental income, with interest on their mortgages reaching $23.9 billion.

But in 2019-20, as the Reserve Bank slashed interest rates before, and then during, the COVID-19 pandemic, landlords’ interest tax deductions fell to $21.7 billion. The collective rental income loss by landlords on their properties shrank to just $240 million, the lowest since the advent of changes to capital gains tax laws in the late 1990s.

Interest rates fell even further in 2020-21, when the Reserve sliced the official cash rate to a record low of 0.1 per cent.

Since May last year, however, the RBA has driven official interest rates up to 3.85 per cent. Some economists believe the bank could use its next meeting, on June 6, to take the cash rate to fresh 11-year high of 4.1 per cent.

At that level, the interest bill on a $600,000 mortgage will have increased by more than $10,000, which investors would be able to claim as a tax deduction.

CPA Australia senior manager of tax policy Elinor Kasapidis said the increase in interest rates would flow directly through to the federal budget bottom line.

“To the extent rising interest rates aren’t mitigated by higher rents, they will result in more negatively geared landlords. This will have a flow-on impact for the federal government’s tax take,” she said.

“Changes in interest rates are a fact of life for long-term property investors. Equally, fluctuations in tax receipts are a fact of life for the government.”

Reserve Bank figures show that between July last year and March this year, property investors paid almost $19 billion in interest on the mortgages held over their rental properties. Over the first nine months of 2021-22, they paid $12.7 billion in interest.

In the first three months of this year alone, investors paid a record $7.1 billion in interest. That interest will be deductible for tax purposes. Total repayments also reached a record $10.9 billion.

CPA Australia senior manager of tax policy Elinor Kasapidis says higher interest rates will be passed through to the federal budget.

This was before the Reserve’s most recent interest rate rise and points to a multibillion-dollar increase in tax deductions by investors against their properties.

Chartered Accountants Australia NZ senior tax counsel Susan Franks also said federal taxpayers would bear some of the cost of higher interest rates through the tax deduction system.

“With rising interest rates, landlords will be claiming larger deductions against their rental income. If rental income has not increased at the same rate as interest and other rental costs, many will be finding that their rental profits are smaller or rental losses are larger. Thus, less will be flowing through to government coffers,” she said.

Franks cautioned investors that the Tax Office was collecting extra data from banks about investment property mortgages and would be looking closely at interest deductions where those loans had been redrawn or refinanced.

She said the Tax Office had already found nine in 10 investment property claims were incorrect.

“Don’t be tempted to include interest that relates to amounts redrawn under the property investment loan for private purposes as a tax deduction,” she said.

The federal Treasury’s latest report on tax expenditures, which measures the cost to the budget of various tax concessions, noted that net rental deductions were likely to jump by one-third to a record $24.4 billion this financial year before increasing again to $26.6 billion in 2023-24.

Deloitte Access Economics lead partner Pradeep Philip said the ability of landlords to claim interest as a deduction would protect renters who are facing large increases in their leases across the country.

“It’s a design feature of the system. When interest rates go down, the cost on landlords goes down, which helps them in terms of rents,” he said. “Negative gearing actually takes some of the pressure off rents as interest rates go up. By being able to claim interest rates as a tax deduction, it takes some pressure off landlords to pass those rate rises in full on to their tenants.”

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