Private ruling: Running a rental property business
Published: May 2013
Ruling period: 1 July 2012 to 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you carrying on a rental property business? | A1: No

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. You would like a ruling stating that the residential investment properties would be considered to be a real estate property investment business under the Income Tax Assessment Act . You have provided a list that forms part of the business real property. Some of the listed characteristics from the tax rulings that you can produce to indicate the existence of a business include: · Copy of the business plan which highlights the marketing plan, operations, management, risk and risk associated with your investments. · Significant capital investment based on the current valuation of the properties. · Profit making purpose - the property investment business produces a positive cash flow from rental income. The strategy to make the investment business more profitable was to reduce debt. · Size of the operations -the portfolio has significant scale and has been able to accumulate and manage the properties professionally. · Existence of business records - the business records are professionally produced and outsourced to your accountant and property managers. · Activities being carried on in a business like manner - all records are stored with them. · Existence of employees - currently there are no employees. All operations of the business are out sourced to third party Accountant and local Property Managers depending upon the location of the properties. The exception to this rule is that you wish to develop two of the properties. You also wish to concentrate on sourcing new properties, provide overall management of the portfolio, liaise with property managers regularly, and review monthly statements and inspection reports, case flow management, taxation and other various central management and control activities. · Length of time over which the activities occur - you have been acquiring properties for approximately 20 years. · Existence of commercial premises - currently there is no commercial premises required as you do not need the advertising space or walk through traffic from tenants whilst you are using your current property managers. · Use of specialised knowledge - you have had many years experience sourcing, managing and developing residential property. Your model has been to acquire properties that have future development potential to increase rental cash flow, provide capital gains with close proximity to the city to maintain good tenants.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 6-5(1), | Income Tax Assessment Act 1997 section 8-1, and | Income Tax Assessment Act 1997 section 995-1.

Reasons for decision: Summary: Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts. This 'ordinary income' includes amongst other things, income from salary and wages and business operations. Section 8-1 of the ITAA 1997 allows you to claim a deduction for a loss or outgoing that is incurred in gaining or producing your assessable income, or necessarily incurred in carrying on a business to gain or produce assessable income. These deductions are limited by the exclusion of losses or outgoings that are capital, private or domestic in nature. | Detailed Reasoning - Carrying on a business: Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business ( Wertman v. Minister of National Revenue (1964) 64 DTC 5158 ( Wertman's Case) ; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172; 87 ATC 4541; 18 ATR 957 ( McDonald's Case ); Cripps v. FC of T 99 ATC 2428 ( Cripps' Case ); Case X48 90 ATC 384; (1990) 21 ATR 3389). Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case, ( Californian Copper Syndicate (Limited and Reduced) v. Harris (1904) 5 TC 159). Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual (paragraph 3 of Taxation Ruling IT 2423). A person who simply owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business, either alone or with other co-owners. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. If rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business (paragraph 5 of Taxation Ruling IT 2423). The issue of whether individuals are carrying on a business of letting property has been considered in a number of cases, some of which are discussed below. In Cripps' Case , the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his 16 properties. In 11 CTBR (OS) Case 24 (Case 24) , the taxpayer's income included rent from three properties. The taxpayer employed a manager and an accountant who was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said: It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices… and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner' ... . In 15 CTBR (OS) Case 26 , ( Case 26 ) the taxpayer derived income substantially from her joint ownership of a block of flats (containing 22 living units) with her sister-in-law. A swimming pool was shared with a neighbouring block of flats owned by the taxpayer's husband and his brother. A garden was maintained and a staff of one caretaker and one cleaner employed on both buildings with casual labour as required. The building was erected and financed by F & Co., the husbands of the joint owners, in the course of their business as building contractors. The general supervision of letting, rent collecting, servicing and maintenance was carried out by the owners or by F & Co. on their behalf. No charge was made by F & Co. for the extensive assistance given in the supervision of the flats. It was held that a business was not being carried on by the owners of the block of flats. On the other hand, Case G10 75 ATC 33 ( Case G10 ), the taxpayer owned two properties of which six units were let as holiday flats for short term rental. The taxpayer, with assistance from his wife, managed and maintained the flats. Services included providing furniture, blankets, crockery, cutlery, pots and pans, hiring linen and laundering of blankets and bedspreads. The taxpayer also showed visiting inquirers over the premises, attended to the cleaning of the flats on a daily basis, mowing and trimming of lawns, and various other repairs and maintenance. The taxpayer's task in managing the flats was a seven day a week activity. The Board of Review held that the activity constituted the carrying on of a business. Taxation Ruling TR 97/11 incorporates the general factors that are considered important in determining the question of whether a business activity is being carried on: · whether the activity has a significant commercial purpose or character · whether the taxpayer has more than just an intention to engage in business · whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity · whether there is regularity and repetition of the activity · whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business · whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit · the size, scale and permanency of the activity, and · whether the activity is better described as a hobby, a form of recreation or sporting activity. TR 97/11 states the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' ( Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' ( Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case. Page 5 of the Rental Properties 2011 (NAT 1729-6.2011) publication provides the following example of taxpayers considered to be carrying on a rental property business: ... the D'Souzas, own a number of rental properties, either as joint tenants or tenants in common. They own eight houses and three apartment blocks, each block comprising six residential units - a total of 26 properties. The D'Souzas actively manages all of the properties. They devote a significant amount of time - an average of 25 hours per week each - to these activities. They undertake all financial planning and decision making in relation to the properties. They interview all prospective tenants and conduct all of the rent collections. They carry out regular property inspections and attend to all of the everyday maintenance and repairs themselves or organise for them to be done on their behalf. Apart from income Mr D'souza earns from shares, they have no other sources of income. The D'Souzas are carrying on a rental property business. This is demonstrated by: · the significant size and scale of the rental property activities · the number of hours the D'Souzas spend on the activities · the D'Souzas' extensive personal involvement in the activities, and · the business-like manner in which the activities are planned, organised and carried on. As shown in the legal cases and the views of the Commissioner listed above, the indicators with the greatest weighting are the scale or volume of operations and the repetition and regularity of the activities. | Detailed Reasoning - Significant commercial purpose: The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. You have purchased four properties. You lease out the properties to tenants. You state that all of the operations of the business are outsourced to a third party accountant and local property managers. You also state that you are using property managers as you have no commercial premises as you do not need the advertising space or walk through traffic from tenants. | Detailed Reasoning - Intention of the taxpayer: The carrying on of a business is not a matter merely of intention, it is a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business. You have provided a business plan. You state that the properties have been purchased in locations where property managers are reputable and have schedule inspections and emergency procedures should an incident occur. This will continue on the properties as you collectively will be designating specific time to begin the process of developing your properties. You state that you will continue with the aid of the property managers to: · examine respective bank accounts for rental collection and reconciliation with the property manager's statement, · liaise with property managers for rental pricing, new tenants and maintaining the leases of the tenancy, and · taxation reporting completed by professional accountants. You state that you wish to develop two of the properties. You also state that you wish to concentrate on sourcing new properties, provide overall management of the portfolio, liaise with property mangers regularly, review monthly statements and inspection reports, cash flow management, taxation and other various central management and control. While you have illustrated an intention in running a rental property business, as indicated in your business plan, from the information provided, the property managers appear to be significantly involved in the day to day operations of your rental properties. | Detailed Reasoning - Prospect of profits: The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business of the taxpayer. As was noted in Wertman's Case , the receipt of income from letting a property to a tenant does not normally amount to the carrying on of a business. You advised that the strategy to make the investment business more profitable was to reduce debt. In your business plan, you have stated that in time the rental properties will increase at least in line with CPI. However, if the supply and demand for residential rentals increased in line with the past five years then its expected rental increases will be more than CPI. | Detailed Reasoning - Repetition and regularity: The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. With regards to letting of properties, repetition and regularity may be measured by factors such as regularity of maintenance, collecting of rent, management and advertising of the properties, insurance, dealing with tenancy agreements and inspection reports. In your case, you state all operations of the business are out sourced to third party accountant and local property managers. You indicate that there is no commercial premises as you do not need the advertising space or walk through traffic from tenants whilst you are using your current property managers. You state that as profits improve with more active strategies, one of you will cut back from full-time employment to 3-4 days per week to continue with acquiring and developing properties. Based on this information, the daily management and operations of the property is conducted by the property managers. The level of repetition and regularity of your activity is not as great as that noted in Case G10. However, your involvement is some what similar to those circumstances noted in Case 24 where the property owners were not considered to be carrying on a business of letting properties. | Detailed Reasoning - Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business: If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business ( IR Commissioners v. Livingston 11 TC 538). This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists. Generally, where a property owner grants exclusive possession of a property to the residents the relationship between the two parties is one of tenant and landlord, and the activity is more likely to be passive investment rather than a business. Similarly, activities constituting the mere maintenance of an asset and the mere collection of income do not indicate the existence of a business of renting premises. In your case, you are renting residential properties to tenants on an arm's length basis through the use of your property manager. Hence the relationship is that of a landlord and tenant. The levels of activities that you perform are not in a similar manner to those of the ordinary trade in that line of business. | Detailed Reasoning - Organisation in a business-like manner, the keeping of books, records and the use of a system: The activities conducted by or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities. You state that the business records are professionally produced and outsourced to your accountant and property managers. While it is anticipated that you keep records in relation to your rental properties, this would also be required by a passive investor of rental properties. | Detailed Reasoning - The size and scale of the activity: The business should be large enough to make it commercially viable. In Cripps' Case , it was held that the renting of 14 two storey townhouses was not a business and in McDonald 's Case it was held that the letting of two units in different strata plans was also not a business. Similarly in Cases 24 and 26 the renting of 22 units and three properties respectively was also not considered a business. In your case, you have purchased 4 rental properties which are leased out to tenants though a property manager. Based on this information, the scale of your activities and volume of operations can be likened to the cases noted above as in your case, there are only four properties. | Detailed Reasoning - Hobby or recreation: The activity does not have the nature of a hobby or recreational pursuit. The nature of the activity is similar to other rental property owners who are actively involved in some aspect of the property they own. | Detailed Reasoning - Conclusion: In your situation, the Commissioner considers that you are not carrying on a business of rental properties. You derive rental income from four properties which are leased on a residential basis as opposed to the operation carried on by the taxpayers in Case G10 . Therefore, the activity could be better described as leasing residential properties to receive passive income from a stream of rental income. You have indicated that all operations of the business are outsourced to a third party accountant and local property managers. From the information provided, you have limited involvement in the day to day operations of your rental properties. The undertaking of managing, level of involvement, scale of activity and volume of operation in the activity is not as great as that noted in Case G10 . However, the circumstances surrounding the management of the properties are some what similar to the owners noted in Case 24. After considering all of the relative business indicators and objective facts surrounding the case it is considered that you are not carrying on a business of leasing residential properties. Income is not derived from the services you provide. It is derived from the letting of the properties and is considered to be passive income.