Private ruling: Rental property expenses
Published: July 2013
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2011

Ruling: Q1: Are the expenses in relation to the holiday home which is rented to a related party at arm's length rates, deductible against the rental income? | A1: Yes. | Q2: Are the expenses in relation to the cottage fully deductible against the rental income? | A2: No. | Q3: Are the expenses in relation to the cottage deductible for the percentage of time that the property was rented? | A3: Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 - Section 8-1.

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature. A number of significant court decisions have determined that for an expense to be an allowable deduction: · it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense ( Lunney v. FC of T ; (1958) 100 CLR 478, · there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. FC of T , (1949) 78 CLR 47 ( Ronpibon's case ), and · it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income ( Charles Moore Co (WA) Pty Ltd v. FC of T , (1956) 95 CLR 344; FC of T v. Hatchett , 71 ATC 4184). Taxation Ruling IT 2167 discusses arms length and non-arms length letting of a property. Generally the approach to be followed is based on whether the rent charged by the owner represents a normal commercial rent. Where property is let at a commercial rent then, apart from the effect of any express statutory provision to the contrary, expenses incurred in letting the property under an arm's length arrangement is generally fully deductible. That is, the arrangement is treated no differently for income tax purposes from any other owner in a comparable arms length situation. In Federal Commissioner of Taxation v Janmor Nominees Pty Ltd (1987) 75 ALR 15; (1987) 15 FCR 348;19 ATR 254;87 ATC 4813 the court had to consider whether the rent received from a residential property purchased by the trust with money borrowed by the trust and rented to associates at a market rate constituted assessable income. The Full Court held that the rental receipts constituted income according to ordinary concepts of the trust. The payment of interest by the trust was an outgoing incurred in the course of gaining or producing the assessable income of the trust. In your case, entity A purchased a property to be rented out as a holiday home for the purpose of producing assessable income. A related party rents the property at normal commercial rates with a written rental agreement in place. It is considered that the rent received constitutes assessable income and any losses or outgoings to the extent to which they are incurred in gaining or producing the rental income of the holiday home will be allowable deductions. | Detailed Reasoning - Cottage expenses: Paragraph 25 of IT 2167 states that a period of time during which a property was available for letting should only be taken into account where it is established that active and bona fide efforts to let the property at a commercial rental were made during the relevant period. In Case P116 82 ATC 590 ( Case P116 ), a property was let for 16 days during the year of income, occupied by the owners for 107 and vacant for the balance of the year. Taxation Board of Review No. 1 apportioned the losses and outgoings attributable to the property on a time basis and allowed a deduction for the proportion that the property was let, that is, 4.4%. Where a property is not actually being rented it will be considered to be 'held' for the purpose of producing assessable income where it is genuinely available for rent as evidenced by the taxpayer undertaking active and bona fide efforts to let the property at a commercial rental. This would include such activities as listing the property with a real estate agent, placing advertisements in newspapers and not restricting availability (for example, by making the property unavailable for rent during holiday periods) to ensure the taxpayer's private use and enjoyment of the property. ( Case R118 84 ATC 773; (1984) 27 CTBR (NS) 13318; Case P116 82 ATC 590; (1982) 26 CTBR (NS) 372; and Case V133 88 ATC 847). In your case, you advertise the cottage in a newsletter. This is not considered to be a genuine attempt to rent the property. The property is only available to family, friends and clients and not to the general public. As active and bona fide efforts to let the property are not undertaken, the property is not being 'held' solely for the purpose of producing assessable income. Accordingly, no deduction is available for ongoing rental expenses associated with the cottage for the period the house was not actually rented or genuinely made available for rent to the public. Taxation Ruling TR 95/33 considers the deductibility and apportionment of losses and outgoings where expenses are incurred for dual purposes. TR 95/33 states that if an outgoing produces an amount of assessable income greater than the amount of the outgoing, there would normally be no need to examine the taxpayer's motives and intentions when determining the deductibility of the expenditure. However, if the outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure to determine whether the outgoing is wholly deductible. This may, depending on the circumstances of the particular case, include an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing. If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective (for example, to derive exempt income or derive income for another entity or the obtaining of a tax deduction), then the outgoing must be apportioned between the pursuit of assessable income and the other objective: see Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613 ( Fletcher 's c ase ). In Ure v Federal Commissioner of Taxation 81 ATC 4100 ( Ure's case ) the derivation of assessable income was not the sole purpose of the loan, and a deduction was only allowed up to the amount of assessable income. When it is necessary to apportion a loss or outgoing, the appropriate method of apportionment will depend on the facts of each case. However, the method adopted in any particular case must be both 'fair and reasonable' in all the circumstances ( Ronpibon's case ). In Fletcher 's c ase , it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year. As in Case P116 , it is considered fair and reasonable in your circumstances to allow a deduction for the percentage of time the cottage was actually rented. A reasonable method to apportion the cottage expenses would be based on the floor area of the property. That is, cottage floor area / total floor area of holiday home and cottage.

Relevant facts: Entity A has purchased a property consisting of a holiday home with a cottage at the back. Both properties are on the same title. | The property and the associated loan are in entity A's name. | The holiday home was originally managed by a real estate agent, however the families that rented the place did not look after it and good services were not provided by the real estate agent. | The holiday home was withdrawn from the real estate agent and is now leased to a related party at market rates. The rent is reviewed and determined annually by obtaining a rental market appraisal from a local real estate agent. | The tenant pays the rent weekly by direct deposit into entity A's account. There is a written rental agreement. | The holiday home is not the main residence of the tenant. The tenant uses the home every two to three weeks. | The tenant pays an additional amount per week above the current market rent to cover electricity costs. | The cottage was also rented and managed by a real estate agent for over 12 months, however the cottage was also taken out of the real estate agent's hands in the relevant income year. | The cottage is leased and advertised to family, friends and clients through a newsletter. The current market rate of rent is always paid by the tenants. Rental income received from the cottage for the relevant income year was less than $3,000. | Entity A has also recently purchased another rental property which is rented to a third party. | All outgoings for the property are paid by entity A.