Investing in renovations in Australia may become a balancing act for your budget, but when you choose the right combination of loans, incentives, and record-keeping, it can be tax-free (or rather, tax-savvy). This guide dissects practical ways Australians can afford renovations without the risk of adding an additional tax bill in the future.
Understanding “Tax-Free” Renovations under ATO Rules
Tax-free renovations in most situations do not mean that the ATO is giving you a free ride; it normally refers to the approach of funding the renovation in a manner that generates no taxable income, and/or creates a legitimate tax reduction through deductions or long-term claims.
The tax result can also vary depending on whether you are living at the property, if it is an investment property, or if part of it is used to earn income (as in the case of a home office).
Best Ways to Finance Home Renovations
Australian Government Solar Rebates & STCs
The federal government of Australia has a program known as the Small-scale Renewable Energy Scheme, where incentives such as Small-scale Technology Certificates (STCs) are given to promote renewable energy systems. The eligible systems include solar PV, solar batteries, solar water heaters, and air-source heat pumps.
The calculation of STCs takes into account factors such as your location, installation date, generated/displaced electricity, and (with batteries) usable capacity. The scheme is established so that STCs can be traded in an auction (where retailers are required to relinquish certificates under the Renewable Energy Target). This gives them financial value that people can use to cover upfront expenses.
Using Renovation Loans (Tax Implications)
Another simple though much-neglected fact: borrowing money to remodel does not normally generate taxable revenue since the funds are a loan, not income.
What becomes interesting in Australia is what you use the refurbished property for—since deductions are usually based upon whether the expenditures and borrowings represent the generation of assessable income (such as rental income).
Investment Property Loans: Deductible Interest Rules
Interest is also deductible if you are renovating a rental property; however, the ATO is categorical that you can only claim the part of the interest related to the purpose of the property (renting) and only when the property is being rented or available for rent. In the event of a mixed loan account (which includes part rental, part private use), the ATO anticipates that the interest should be apportioned. They provide calculation methods and examples in their guidance (although they do not compel the accountant to use strictly one method).
Practical implication: Do not pollute your renovation financing by refinancing a rental property loan to spend the funds on personal purposes. This reduces the deductible portion and contributes to future apportionment headaches.
Interest-Free Finance & Buy Now Pay Later Risks
Promotional finance (such as 0% instalments) can be a convenient cash-flow device, and it is tax-neutral since, once again, you are borrowing rather than earning income. The actual threat is financial: in case you fail to take action during a promo period, the interest rate often skyrockets and eliminates the benefit.
Managing Renovation Scope & Budget
It becomes more difficult to finance with a fuzzy scope, as lenders (and you yourself) are not fond of unexpected expenses. This is even more true when you are attempting a full home remodel, whereby trades, sequencing, and materials can move your schedule quickly.
One easy mechanism to safeguard your cash flow is to isolate necessary work (safety, leaks, compliance) from purely cosmetic work, so that you can halt the optional work if costs escalate.
Renovation Tax Deductions: ATO Rules Explained
ATO Rules: Repairs vs Improvements
In the case of residential rental property, the ATO sets out the rules for claiming repair and maintenance and outlines the circumstances under which the costs can be deductible. Generally speaking, work that restores something (repair/maintenance) is not considered the same as work that improves or installs something new (improvement/capital works), which typically is not an immediate deduction.
This difference is important because trying to state that something was a direct repair even though it entailed an enhancement could create an issue in the event the ATO reviews your return.
Division 43 Capital Works Deductions
If your renovation is capital in nature (excluding minor work) on an investment property, it may be classified as capital works deductions (generally referred to as Division 43). According to ATO guidance, a rate of 2.5 percent would distribute the claims over 40 years (and a rate of 4 percent would distribute the claims over 25 years in certain cases).
Division 40 Property Depreciation & Plant Assets
Under ATO rules, you can deduct the decline in value of depreciating assets that are used to produce income (such as a dishwasher used in a rental property).
There are, however, certain limitations on the deductions you can claim on second-hand depreciating assets for residential rental premises. In most cases, you will only be able to claim deductions on these assets if they were purchased prior to 7:30 pm on 9 May 2017 and installed prior to 1 July 2017 (otherwise different rules apply).
Capital Gains Tax (CGT) Cost Base
According to the ATO, the cost base of a CGT (Capital Gains Tax) asset may comprise capital costs incurred to grow or sustain the value of the asset (which may include some forms of improvement). However, the ATO also notes that you usually cannot offset costs that are already tax deductible; thus, in case you claimed capital works deductions, these items may not be included in the cost base.
This is particularly applicable where a property is (or becomes) income-generating, or where you do not otherwise qualify for the main residence exemption.
Record Keeping for Tax-Effective Renovations
The least troublesome way to substantiate intentions for tax purposes is tedious but effective: maintain clean books and separate categories.
The following is a basic arrangement that greatly simplifies the process of ATO compliance for rentals:
- Record Repair and Improvement differently, as they are not claimed in the same way.
- If you are claiming interest on your loan, maintain a record of what the borrowed money was spent upon, particularly where there is any personal use (due to the apportionment requirement of the ATO).
- Record capital works expenditure (structural/building-style expenditure) separately, as the ATO characterizes capital works deductions with specific rates and time periods.
- Keep invoices of depreciating assets that provide rental income, since the deductions are associated with the loss of value of these assets.
Summary: Building a Tax-Efficient Renovation Strategy
For Australians, the optimal renovation financing plan most likely involves a combination: take federal clean-energy incentives such as STCs where your upgrade qualifies, finance the balance through borrowing that fits your schedule, and maintain your records to take advantage of what you are entitled to (and nothing more). The ATO regulations on apportionment of interest, repairs and improvements, capital works, and depreciating assets may substantially alter the after-tax cost of renovating if your project involves an investment property.
If you have a complicated situation (mixed-use loans, major capital works, or CGT questions), getting early custom advice will save you from many mistakes later. Assuming you already have an adviser you trust, that is superb; otherwise, having a specialist such as Bargo Tax Accountants design the most compliant route through the structure and documentation can save you a lot of future headaches.
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