Private ruling: Rental property and the division of net rental income or loss between co-owners
Published: November 2013
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you assessable on rental income derived from the jointly owned property one, but which was received solely by your former spouse, during the period after your marriage breakdown to the date of the final property order? | A1: Yes. | Q2: Are you assessable on rental income derived from the jointly owned property two, but which was received solely by your former spouse, during the period after your marriage breakdown to the date of its sale? | A2: Yes. | Q3: Are you entitled to claim a deduction for 100% of the expenses (interest and other property expenses such as rates, repairs and maintenance) which you solely paid and your former spouse did not contribute to, in respect of the above properties? | A3: No.

Relevant facts and circumstances: You and your former spouse owned two properties jointly, in equal shares. Your marriage broke down. Property one was rented the whole time and was transferred to your former spouse pursuant to a Family Law Court final property order. Under this order, all your right, title and interest in this property was to be transferred to your former spouse within a specified period of time after the date of the order. Your interest in property one was transferred to your former spouse in the income year following the final property order. You and you former spouse had previously lived in property two. It was rented for a number of months, and then it was sold pursuant to an interim order. The interim order dealt with property two only. It stated that this property was to be listed for sale, and that if it hadn't been sold privately by a certain date that it had to be put up for auction. After your marriage breakdown you still held property two jointly with your former spouse, until it was sold. The sum of money from the sale of property two was held in a solicitor's trust account until the Family Law Court final property order. Pursuant to the final property order, contemporaneously with the transfer of property one, the proceeds of sale of property two was to be deposited into an interest bearing trust account for you and your former spouse's child, until the child turns a certain age. After your marriage break down there wasn't any agreement between yourself and your former spouse regarding the properties. Your former spouse contacted the real estate agent and had the rent money paid into her/his private account, but you did not agree to this. However, to keep the houses you were forced to solely pay interest. You had to pay for all the interest and other property expenses such as rates, repairs and maintenance. Your former spouse did not contribute. You did not get reimbursed for any of these expenses or receive any income after your marriage breakdown. The loan(s) on which you paid interest was a joint loan(s), in both names. You were paying all the interest and repayments after the marriage breakdown.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 995-1(1) | Income Tax Assessment Act 1936 Subsection 92(1) | Income Tax Assessment Act 1936 Subsection 92(2)

Reasons for decision: Summary: The net rental income or loss (income less allowable deductions) from property one must be shared equally up until the date of the Family Law Court final property order. From the date of that order, you no longer have an equitable interest in the property and therefore do not have to include any net income or loss from the rental of the property. The net income or loss from the rental of property two must be shared according to the legal interests of you and your former spouse. You owned the property in equal shares, so the net rental income or loss must be shared equally. | Detailed Reasoning - Partnerships: The term partnership is defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 as an association of persons carrying on business as partners or in receipt of income jointly. An individual who derives income from the rent of one or two residential properties would not normally be carrying on a business (Taxation Rulings TR 93/32 and IT 2423). TR 93/32, which explains the basis upon which the net income or loss from rental property should be divided between co-owners, states that as a general proposition, it is more accurate to describe the owners of rental property as co-owners in investments rather than as partners in a business operation. In your case, there was a mere investment in property which yielded rent rather than participation by you and your former spouse in a business activity. You were co-owners of two properties in which you each owned a 50% share, and so were in receipt of income jointly. Therefore, a partnership existed for taxation purposes. | Detailed Reasoning - Income and deductions of a partner in a partnership: Subsection 92(1) of the Income Tax Assessment Act 1936 provides that the assessable income of a partner shall include so much of the individual interest of the partner in the net income of the partnership of the year of income. 'Net income' means the assessable income of the partnership less all allowable deductions. Subsection 92(2) states that if a partnership loss is incurred by a partnership in a year of income, a deduction is allowable to a partner of so much of the individual interest of the partner in the partnership loss. 'Partnership loss' means the excess (if any) of the allowable deductions over the assessable income of the partnership. Therefore, as a partner, you are required to include so much of your individual interest of the net income or loss of the partnership (the jointly owned rental properties) in your tax returns for the relevant income years. | Detailed Reasoning - Interests in rental property: Generally, a legal interest in land is achieved by the owner being the registered proprietor of the legal title to the land. TR 93/32 states that the net income or loss from a rental property must be shared according to the legal interest of the owners except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title. You and your former spouse owned the properties jointly in equal shares, so you each held an identical 50% legal interest. The net income or loss from the rental of these properties must be shared accordingly, unless there is sufficient evidence to establish that your equitable interest is different from this legal interest. | Detailed Reasoning - Legal and equitable interests: In certain circumstances, agreements between co-owners and Family Court orders dealing with settlement of joint owned property may alter the equitable interests of the co-owners from the date of that agreement or order. (Their legal interests in the property would not change until the relevant legal title is transferred). Property one was transferred to your former spouse pursuant to a Family Law Court final property order. Under this order, all your right, title and interest in this property was to be transferred within a specified period after the date of the order. Your interest in this property was transferred to your former spouse in the income year following the date of the final property order. The Family Law Court final property order is evidence that your equitable interest in property one was different from your legal interest from the date of that order. After your marriage breakdown you still held property two jointly with your former spouse, until it was sold. There is not sufficient evidence in your case to establish that your equitable interest in this property was different from your legal interest. | Detailed Reasoning - Property one: The Family Law Court final property order confirms that your former spouse had a 100% equitable interest in property one from the date the order was made, even though legal title was not transferred to your former spouse until after that date. Accordingly, your equitable interest in the property was different from your legal interest from the date of the final property order. Therefore, the net rental income or loss from the property must be shared equally up until the date of the final property order. From the date of that order, you no longer have an equitable interest in property one and therefore do not have to include any net income or loss from the rental of the property. | Detailed Reasoning - Property two: The net income or loss from the rental of property two must be shared according to the legal interests of you and your former spouse. You owned the property in equal shares, so the net rental income or loss must be shared equally. | Detailed Reasoning - Effect of the payment of property expenses solely by you: The fact that after your marriage breakdown your former spouse received all of the rental income but paid none of the property expenses (interest and other property expenses such as rates, repairs and maintenance) has no effect. TR 93/32 states that the fact that one co-owner has paid all the expenses on the property is of no consequence for income tax purposes. The payment by a co-owner of the other co-owner's share of expenses is simply treated as a loan to the other co-owner. Expenses that relate to a property as a whole (such as interest on joint borrowings, rates and repairs) remain a partnership deduction. The pocket that these expenses are paid out of is irrelevant. A co-owner cannot claim a deduction for all of these expenses, because the expenses are being met on behalf of the partnership. In Case 63/96 96 ATC 578; Case 11324 34 ATR 1018, the taxpayer and his spouse purchased a property as joint tenants. The taxpayer solely borrowed funds to refinance the joint borrowings on the property. He claimed that the total interest paid on the borrowing in his name, for which he was solely responsible and paid for, was deductible against his assessable income. It was held that he was not entitled to a deduction for the whole of the interest on the new borrowings as it was to fund the joint interest, not the interest of the taxpayer alone. Senior Member BH Pascoe stated (at ATC page 582; ATR page 1021): ... it would seem that where two people agree to jointly purchase a property for rental purposes and one borrows money solely for the purpose of contributing his or her share of the purchase price, then the interest on that borrowing would be an expense of the borrower and deductible from his or her share of the net rental income. It would not be appropriate that such interest be required to be taken into account in arriving at the net income of the partnership. On the other hand where the parties jointly incur an expense related to the property as a whole such as rates, insurance and interest on borrowings to fund the joint equity, such expenses must be taken into account in arriving at the net income of the partnership notwithstanding that the payment of the expense was made by one of the partners only. However, it should be noted, that some deductions may be allowable to individual partners (co-owners). For example, motor vehicle expenses incurred to inspect a rental property. This is because these expenses relate to the running of the individual partners own motor vehicle, and not to the property as a whole. The expenses that you solely paid for in respect of the properties (interest on the joint borrowing, rates and repairs and maintenance) relate to the property as a whole, and are therefore partnership deductions. Consequently, you are not entitled to a claim a deduction for 100% of these expenses.