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Ruling

Subject: Rental property deductions

Question 1

Are you restricted in the amount of deductions you incur for expenses on a rental property that is rented for less than market value?

Answer

Yes.

This ruling applies for the following periods:

The year ended 30 June 2010

The year ending 30 June 2011

The year ending 30 June 2012

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You and your spouse purchased a rental property.

The property was in a good condition.

You financed the purchase of your property with an interest only loan in the names of you and your spouse.

The loan amount covered the following amounts property purchase, conveyancing costs, stamp duty, pest inspection and a building inspection report.

You signed the contract for purchase and settlement for the property occurred in the same year. Your tenants moved in during the particular year and rent has been charged from this date.

You and your spouse are tenants in common.

You and your spouse manage the property.

The tenants are related parties.

The property is not rented at market rate.

You would like to claim expenses for interest, water rates, security alarm service and landlord insurance.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Rental deductions

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. The exception to this is where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

As rental income is assessable income, deductions incurred in producing this income may be allowable under section 8-1 of the ITAA 1997.

Rental property leased to relatives

Taxation Ruling IT 2167 provides the Commissioner's view of the law in relation to deductions for rental properties that are leased to relatives. The views of this ruling are also expressed in the publication Rental Properties (NAT 1729).

According to IT 2167 ordinarily where a taxpayer grants a lease or licence of property, whether wholly or in part, whether at arms length or otherwise, the amount received as rent or in respect of the licence is assessable income. IT 2167 further explains that it is necessary to make the qualification "ordinarily" because some cases may arise, particularly where the arrangements are not at arm's length, where an amount described as or said to be rent is not of income nature and, therefore, not assessable income.

In FCT v. Groser, 82 ATC 4478: 13 ATR 445 (Groser), for example, the taxpayer permitted his invalid brother to live in a house which the taxpayer owned. The taxpayer arranged to receive his brother's invalid pension so that he could use the moneys to provide for the brother's maintenance. It was arranged that $2 per week would be deducted for rent of the taxpayer's house. The Court held that the weekly amounts of $2 were not assessable income. They were a contribution to the funds out of which the taxpayer proposed to maintain his brother. The arrangements were simply not of a kind which produced a receipt of income as that term is normally understood.

According to paragraph 13 of IT 2167 where a property is let to relatives the essential question is whether the arrangements are consistent with normal commercial practices in this area. If they are, the owner of the property would be treated no differently for income tax purpose from any other owner in a comparable arms length situation.

However, paragraph 14 of IT 2167 states that, if the property is let to relatives at less than commercial rent other considerations arise. Unless the arrangements are comparable to those in Groser referred to earlier, the rent would represent assessable income. It would not necessarily follow, however, that losses and outgoings in relation to the property would be wholly deductible. The ultimate resolution of the matter would depend upon the purposes of the taxpayer in acquiring the property and in letting out to relatives.

In FCT v. Kowal, 84 ATC 4001: 15 ATR 125, for example, the Court found that the taxpayer had two purposes or objects in mind in acquiring the relevant property. One was to provide his mother with a good home at moderate cost. The other was to earn assessable income. The Court further found that the second purpose or object was the predominant one and, in the result, allowed income deductions for 80% of the losses and outgoings falling within sub-sections 51(1) and 67(1). In Groser, on the other hand, the Court expressed the view that, if the weekly rental had been assessable income, it would have allowed no more than $104 by way of deduction under sub-section 51(1) - the reason for this being that private or domestic purposes for the expenditure predominated over the purpose of producing assessable income.

Paragraph 16 of IT 2167 explains that decisions in these cases will ultimately depend upon the facts of each case. As a matter of experience it is unlikely that there will be sufficient information provided in return forms to enable a final decision to be made. In these circumstances, and as a working rule, income tax deductions for losses and outgoings incurred in connection with the rented property may be allowed up to the amount of rent received. Whether any additional deduction is to be allowed will depend upon the nature of any further information provided by the taxpayer.

According to IT 2167, if you let a property or part of a property at less than normal commercial rates, this may limit the amount of deductions you can claim. As outlined in the publication Rental Properties, generally if non commercial terms or rates are used then the amount of deduction you can claim is limited to the amount of rental income received from this type of non-commercial arrangement. In other words, it is limited to the income you earn.

Deductibility of rental property expenses

In your case you and your spouse own a rental property that you are currently leasing to your daughter and her husband. You charge your daughter and husband a rate for rent that is less than the market value rate of rent and as such this is a non-arms length arrangement. As a result it is questionable as to whether the amounts you receive are assessable and, therefore, the deductions allowable. However if the amounts were to be assessable the deductions you can claim are restricted to the amount of income you receive from the property. In other words the deductions you claim can only be applied to reduce the rental income to nil and any excess deductions, you may have, can not be applied to reduce other income.

Consequently you are unable to claim the full deduction for your expenses from the rental property as it is restricted by the income you receive.

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