Income from leasing of real property

Record keeping – source documents

Good record keeping supports the ATO’s ability to assure that Top 500 groups are paying, and will continue to pay, the correct amount of tax. Record keeping is also a requirement under Division 121 and section 262A.

The tax governance policy of the group should include procedures for maintaining a central repository for documentation that records:

• the acquisition and disposal of real property investments held by the group (including dates of acquisition and disposal, cost of acquisition, proceeds on sale)
• income derived and expenses incurred by the group from leasing real property.

Completeness of leasing income disclosures

Has all income from leasing real property been identified and disclosed in the entity’s tax returns?

The tax governance policy of the group should include procedures for correctly capturing and recording income from leasing of real property.

Deductibility of outgoings

Have allowable deductions from holding and leasing real property been correctly characterised and quantified?

The tax governance policy of the group should include procedures for:

• explaining, reviewing and recording outgoings typically incurred by the group in deriving income from leasing real property
• ensuring that any expenditure on the property is correctly characterised (deductible maintenance or capital additions/works)
• calculating capital allowances on depreciating assets
• quantifying any capital works deductions that may be available.

Leasing income and allowable deductions are reported in the correct period

Has all income derived and expenditure incurred from the group’s activities in leasing real property been properly referred to the correct income year?

The tax governance policy of the group should include procedures for:

• ensuring that functionaries within the group understand how and when income and expenses associated with real property leasing activities should be recognised for both accounting and tax purposes
• ensuring any timing differences between the accounting and tax treatments applied to typical income and expenses associated with the group’s property leasing activity are documented and captured on the relevant group entity’s tax reconciliation
• correctly recognising tax adjustments for any lease incentive arrangements that are in place.

Characterisation and calculation of capital gains and losses on the disposal of investments in real property.

Has the vendor entity correctly characterised and calculated gains and losses made on the sale of investments in real property?

The tax governance policy of the group should include procedures for:

• correctly characterising and calculating capital gains or losses made on the sale of real property, including (but not limited to):
  • whether gains or losses are on capital (or revenue) account
  • the accuracy of cost base and proceeds calculations
  • the vendor entity’s eligibility for the CGT discount
  • cost base adjustments (for example División 43 exp.)
  • current and prior year capital losses (if available)
  • making adjustments for ‘mark-to-market’ accounting
• seeking advice to help ensure that the calculation and timing of any capital gain or loss that the group has made is correct.

Correct reporting

Has the entity who derived the income, or who made the capital gain or loss, correctly reported the income or capital gain or loss?

The tax governance policy of the group should include procedures for ensuring income and capital gains tax information is migrated across from the working papers and correctly disclosed in the relevant entity's tax return.

1

The John Simple group shall maintain a central repository for documentation concerning:

• acquisitions and disposals of real property assets and related costs
• leasing and other income
• expenditures incurred
• in the course of the Simple group’s real property leasing activities.

Acquisitions and disposals of real property investments will be recorded in the Excel spreadsheet entitled “Real Property Investment Register” within 7 days of contract completion for the acquisition or sale.

The spreadsheet will record:

• address
• date of acquisition
• cost of acquisition
• ancillary costs of acquisition (such as stamp duty, legal fees)
• sale price (plus any ancillary costs)
• date of sale..

Bill Bookkeeper informed by the Simple group’s lawyers and tax agent.

To support good record keeping practices over all of Mr Simple’s investments in real property and to ensure that the Simple group is compliant with its record keeping obligations.

2

At the time of any changes to the Simple group’s real property portfolio (additions, disposals, capital works, major maintenance), or at the end of each 3 month period, back up electronic copies of documentation in the central repository and the Real Property Investment Register to a hard drive, or memory stick.

Bill Bookkeeper

Ensure records of Mr Simple’s investments in real property are not lost in the event primary information sources are compromised.

3

As well as each monthly report prepared by the property manager, the property manager will provide an annual summary of income and expenses for each property investment as at the end of the financial year.

Bill Bookkeeper as informed by the property manager

Summarises leasing income earned for the financial year and outgoings paid to the agent for their services. Allows for reconciliation back to monthly data and bank statements.

4

Repairs and maintenance (R&M)

Receipts to be retained and maintained (by property) for all R&M expenditure. Where repairs are managed through the property manager, receipts to be furnished, downloaded and stored.

R&M expenditure will be recorded in the Excel spreadsheet entitled 'Rental property financial accounts'' and be referenced to the relevant property, within 3 days of payment of the invoice. Accumulated totals should be maintained within the spreadsheet.

Bill Bookkeeper

Ensure records of Mr Simple’s investments in real property are not lost in the event primary information sources are compromised.

5

Interest expense

Documentation regarding any external financing obtained to acquire or improve real property assets is to be retained. Documentation should include points explaining:

• the date the finance was obtained
• the purpose of obtaining finance
• how the finance was applied, and
• the applicable interest rate or other terms upon which the finance was obtained.

Interest expenses are recorded in the Excel spreadsheet entitled 'Rental property financial accounts'. Accumulated totals should be maintained within the spreadsheet.

Bill Bookkeeper as informed by Simple groups lawyers or tax agents

Support the John Simple property trust’s claim for interest deductions that are associated with the debt funding of its property portfolio (where and when required).

6a

Depreciation (Division 40)

On initial acquisition of real property, a tax depreciation schedule will be obtained from a qualified valuer or quantity surveyor.

Bill Bookkeeper and Simple group’s tax agents/advisors

To help ensure that the John Simple property trust is using the correct tax cost bases when determining the amount it can claim as capital allowance

6b

The costs of existing and new depreciable assets held by the John Simple Property Trust are to be recorded on an Excel spreadsheet entitled 'tax fixed asset register' that includes:

• a description of the asset
• the date asset was ready for use
• a calculation of the assets tax cost
• the method and rate of depreciation applied to the asset
• the capital allowance claim for the year
• the assets closing cost.

For purpose of calculating depreciation, use the Commissioner’s effective lives for depreciating assets guidance as published each year in the ATO’s Taxation Ruling.

For all new depreciable capital assets that are acquired, receipts are to be maintained and referenced against the tax fixed asset register (including low value pools).

Bill Bookkeeper and Simple group’s tax agents/advisors

To support the John Simple property trust’s claim for capital allowance deductions in the year of income in which the claim is made.

6c

Where depreciable assets are disposed of, the tax fixed asset register will record:

• the date of the disposal
• sale price
• the balancing income/loss recognised on disposal.

To help ensure that gains or losses on disposal of depreciable capital assets by the John Simple property trust are calculated correctly for tax purposes.

7a

Capital works (Division 43)

Upon acquisition of an existing real property asset that's not vacant land, a determination will be made about the percentage rate at which capital works deductions can be claimed.

On initial acquisition of an existing real property, a tax depreciation or capital works schedule will be obtained from the property’s previous owners or obtained from a qualified quantity surveyor.

Upon incurring new expenditure on capital works, a determination will be made about the percentage rate at which capital works deductions can be claimed.

Note: Generally, the Simple group acquires assets for which the 2.5% rate is applied.

Bill Bookkeeper and Simple group’s tax agents/advisors

Ensure that the John Simple property trust’s is eligible to claim capital works deductions in respect to a particular property, the cost base by reference to which capital works deductions can be claimed and the percentage to be used when claiming capital works deductions each year.

7b

For new capital works, receipts should be retained and referenced against the tax fixed asset register.

Details of new capital works are recorded on an Excel spreadsheet entitled 'tax fixed asset register' that includes a

• description of the capital works
• date the capital works were completed
• cost of the capital works
• percentage deduction rate applied (for example 2.5%)
• deduction claimed for the year
• closing balance of unclaimed construction expenditure at year end.

Any complex issues concerning the application of, or calculations required by Division 43, should be escalated to the Simple group’s tax advisors.

Bill Bookkeeper and Simple group’s tax agents/advisors

Substantiate capital works deductions for the year. Help ensure compliance with the Simple group’s record keeping obligations.

Support the John Simple property trust’s claim for capital works deductions.

Accessing sophisticated levels of advice helps ensure complex issues with capital works claims are treated correctly.

8

Other expenses

A list has been (or should be) prepared and retained that outline and explains typical expenses incurred by the John Simple property trust in the course of its property leasing activities.

Accounting expenses should be recorded (by property) in the Excel spreadsheet entitled 'Rental property financial accounts for the year ended 30 June 20XX', within 3 days of the supplier invoice being received. Accumulated totals should be maintained within the spreadsheet.

Bill Bookkeeper

Ensuring typical expenses associated with each property portfolio are understood and explained - for succession planning.

Support John Simple property trust’s claims for allowable deductions.

9

Prepaid expenses

Where eligible expenditure has been prepaid, maintain records of prepayments. Prepare an accompanying note that explains the nature of the prepaid expenditure and relevant time period to which the expenditure relates (more or less than 12 months).

Bill Bookkeeper

Help with preparation of the John Simple property trust’s draft tax reconciliation.

Support John Simple property trust’s claims for allowable deductions.

10

Before forwarding information to the Simple group’s tax agent, review the following spreadsheets and resources against a sample of documentation to sense check that income and expenses have been captured and correctly recorded.

• Real Property Investment Register
• List of typical expenses
• Tax and accounting fixed asset register

Bill Bookkeeper

Helping ensure that Mr Simple’s income and expense disclosures are complete.

11

At least 4 weeks before the due date for lodgment of the John Simple property trust’s tax return, provide the Simple group’s tax agent with:

• a summary narrative about the John Simple property trusts typical and atypical activities during the year.
• real property investment register
• the property manager’s end of financial year summary statement for each property investment
• excel rental property financial accounts
• tax and accounting fixed asset registers
• related source documents as required by the tax agent
• notes concerning any prepaid expenses.

Bill Bookkeeper

Ensuring the John Simple property trust’s tax return is lodged on time.

Helping the tax agent with the process of preparing the John Simple property trust’s tax return.

12

Tax agent to provide an annual engagement letter to Mr Simple that specifies the tax agent and Mr Simple’s responsibilities under the engagement with the Simple group.

TAG & Mr Simple

To provide clarity around Mr Simple’s responsibility for providing complete and accurate information, and the tax agents responsibility for:

• preparing the John Simple property trusts special purposes financial accounts, and
• ensuring that all leasing income, allowable deductions and any capital gain (losses) are correctly recorded in the John Simple property trust’s income tax return.

13

Perform a logic check over the quantum of leasing income, expenses and any balancing adjustments for the John Simple property trust.

Tax agent

Integrity check over primary data source from which leasing income and related expense information is obtained.

14

Prepare financial accounts, including accruals. The accounts should be prepared in accordance with relevant accounting standards.

Tax agent

Maintenance of accurate financial records for the John Simple property trust.

15

Review expenses, capital allowances, capital works, and prepaid expenses for tax deductibility, including whether an apportionment of any expenditure is required (for example, property not available for lease at all times throughout the year, or where property has been used for private purposes).

Tax agent

Correct characterisation and quantification of expenses as allowable deductions.

16

Calculate capital gains and losses on any disposals of real property assets that occurred during the year.

As a competent professional Mr Simple’s tax Agent is across the issues that are relevant to the correct calculation of gains and losses arising from the disposal of real property.

Tax agent

Correct calculation of the John Simple property trust’s capital (or revenue) gains and losses.

17

Tax reconciliation

• Prepare John Simple property trust tax reconciliation including taking steps to add back:
  • non-deductible repairs and maintenance outgoings
  • current year’s closing balance of each accrued expenditures (CY BS). The previous year’s closing balance of accrued expenditures (PY BS) are to be subtracted on the tax reconciliation
• Deduct the current year’s closing balance of each eligible prepaid expenditure (CY BS). The previous year’s closing balance of prepaid expenditures (PY BS) should be added back on the tax reconciliation.
• Add-back accounting depreciation and subtract tax depreciation and capital works deductions
• Subtract (add-back) any M2M accounting gains (losses) on real property assets.
• Recognise (add-back) any realised net capital gains on sale of real property.

Note: Capital works that have been claimed as an allowable deduction should be deducted from the cost base of the real property when calculating any capital gain or loss.

Tax agent

The tax reconciliation for the John Simple property trust has been prepared correctly and the adjustments can be easily explained.

18

Retain and file working papers

Tax agent

Retention of records that support the John Simple property trust’s tax return disclosures.

19

Leasing income received during the year is migrated across from the real estate property lease summary and the rental property financial accounts to Mr Simple’s income tax return.

Tax Agent

Correctly capture leasing income in the John Simple property trust’s tax return.

20

Expenditures incurred during the year are migrated across from the rental property financial accounts, and the necessary book-to-tax adjustments are recorded in the appropriate tax reconciliation label fields within the John Simple property trust’s income tax return.

Tax Agent

Correctly capture allowable deductions and required adjustments in the John Simple property trusts tax return.

21

Capital gains tax calculations carried out by the tax agent are migrated from working papers across to the John Simple property trust’s tax return.

Tax Agent

Ensure capital gains and losses are correctly reported.