Edited version of your written advice

Authorisation Number: 1051233167720

Date of advice: 13 June 2017

Ruling

Subject: Am I in business - Rental properties

Question 1:

Do your rental property activities constitute a business for income tax purposes?

Answer:

No.

Question 2:

Are the rental properties active assets for capital gains purposes?

Answer:

No.

This ruling applies for the following periods:

2014-15 income year

The scheme commences on:

1 July 2002

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.

This private ruling relates to your ownership of and your income earning activities from X residential rental properties.

Property A

You acquired the property some 20 years ago. It was vacant for a short time.

The property was occupied by the first tenants for XX months.

The property was occupied by new tenants for XX years.

The property was occupied by a different tenant for a short time.

The property was then occupied by the final tenants until the tenancy was terminated early due to sale. (It was supposed to run for XX months.)

You used general tenancy agreements in relation to these occupancies.

You recently sold the property and have calculated a capital gain of about $150,000. Your share of the capital gain is 1%.

You used a property agent to manage the property.

Property B

You acquired the property some 35 years ago. It was your main residence until 2X years ago.

The property was then occupied by tenants for XX years.

The property was occupied by new tenants for X years.

The property was then occupied by the final tenants until the tenancy was terminated early due to sale. (It was supposed to run for X years.)

You used general tenancy agreements in relation to these occupancies.

You recently sold the property. You have not calculated a capital gain or loss for the property.

You used a property agent to manage the property.

Property C

You acquired the property some ten years ago.

Unit 1 of the property has been occupied continuously by one tenant.

Unit 2 of the property was occupied by a tenant for X years.

Unit 2 of the property was occupied by a new tenant for X years.

Unit 2 of the property has since been occupied by a different tenant.

You used general tenancy agreements in relation to these occupancies.

You used a property agent to manage the property.

Property D

You acquired the property some ten years ago.

The original tenants moved out of the property as soon as you bought it. It was then vacant for a little while.

The property was occupied by tenants for X months.

The property was occupied by new tenants for X months.

The property was occupied by a different tenant for XX months.

The property was occupied by another new tenant for XX months.

The property was occupied by the next tenant for X months.

The property was occupied by another different tenant for XX months.

The property was occupied by another new tenant for X months.

The property was then occupied by the final tenant.

You used general tenancy agreements in relation to these occupancies.

You recently sold the property and have calculated a capital gain of about $50,000. Your share of the capital gain is 50%.

You used a property agent to manage the property.

Property E

You acquired the property some ten years ago.

The property was occupied by tenants for XX months.

The property was occupied by new tenants for X years.

The property was then vacant until you sold it.

You used general tenancy agreements in relation to these occupancies.

You recently sold the property and have calculated a capital loss of about $70,000. Your share of the capital loss is 50%.

You used a property agent to manage the property.

Property F

You acquired the property some ten years ago. It was then vacant for a short time.

The property was occupied by tenants for X years.

The property was occupied by new tenants for X months.

The property was occupied by different tenants for XX months.

The property was then vacant until you sold it.

You used general tenancy agreements in relation to these occupancies.

You sold the property some X years ago. You have not calculated a capital gain or loss for the property.

You used a property agent to manage the property.

Property G

You acquired the property about X years ago. It was vacant for a short time.

The property was occupied by a tenant for XX months.

The property was then vacant until you sold it.

You used the general tenancy agreement in relation to this occupancy.

You recently sold the property. You have not calculated a capital gain or loss for the property.

You used a property agent to manage the property.

You received about $40,000 per year as rent from these properties. Expenses were about $55,000 per year leaving a net loss of about $15,000 each year.

You have the following agreement in relation to the properties where you have a particular agent:

● You as owner are responsible for maintaining the houses

● The agent conducts the property inspections

● The agent renews expiring leases (but takes instruction from you and seeks your approval)

● The agent presents the tenants to you for approval

● The agent undertakes market analysis when setting the rental price (but you can influence the asking price)

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Division 152,

Income Tax Assessment Act 1997 Division 328 and

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Question 1

Summary

Your rental property activities do not constitute a business for income tax purposes.

Detailed reasoning

You contend that:

● Your activity of residential property leasing is being undertaken for commercial reasons and the main intention is to make a profit.

● You have more than one property that is used to pursue this activity.

● The amount invested is significant.

● The activity is planned, organised and carried out in a business-like manner.

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'.

Generally, the receipt of income from the letting of real property to tenants does not amount to the carrying on of a business.

Therefore, a person who simply owns an investment property or several investment properties, either alone or with other co-owners is usually regarded as an investor who is not carrying on a rental property business. There must be something special about the activity to reach the conclusion that a business is being carried on. This will generally relate to the provision of additional services to the client in a manner that enhances the gross return above investment levels.

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 v. FC of T 99 ATC 2428; (1999) 43 ATR 1202 (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 rents from three properties. The taxpayer employed a manager and an accountant - he 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, &c., 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 Income Tax: am I carrying on a business of primary production? (TR 97/11) provides the Commissioners view of the factors used to determine if a taxpayer is in business for tax purposes. Its principles are not restricted to questions of whether a primary production business is being carried on.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

● 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.

These factors are framed in TR 97/11 to reflect that the alternate outcome is as described in the final dot point. The analysis in your case must reflect that the alternate outcome would be to conclude that your activities are an investment.

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.

In the Rental Properties 2015 guide (Rental Properties guide) published by the Australian Taxation Office the Commissioner sets out two examples that discuss the issue of whether or not the owner of one or more rental properties can be said to be carrying on a business.

The first example, Example 4 on page 5 of the guide, outlines a situation in which the owners are not carrying on a rental property business. The Commissioner states:

The Tobin’s own, as joint tenants, two units and a house from which they derive rental income. The Tobin’s occasionally inspected the properties and also interview prospective tenants. Mr Tobin performs most repairs and maintenance on the properties himself, although he generally relies on the tenants to let him know what is required. The Tobin’s do any cleaning or maintenance that is required when tenants move out. Arrangements have been made with the tenants for the weekly rent to be paid into an account at their local bank. Although the Tobin’s devote some of their time to rental income activities, their main sources of income are their respective full-time jobs.

The Tobin’s are not partners carrying on a rental property business - they are only co-owners of several rental properties.

The second example, Example 5 on page 6 of the guide, outlines a situation in which the owners are carrying on a rental property business. The Commissioner states:

The D’Souza’s 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’Souza’s actively manage all of the properties. They devote a significant amount of time - an average of 25 hours per week - 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 collection. 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’Souza’s 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’Souza’s spend on the activities;

● the D’Souza’s 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 above 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.

Applying the relevant cases and indicators to your circumstances

In many instances, it is obvious that an activity is being carried on as a business and no further investigation is required.

Where it is less obvious, regard must be had for any other potential outcome when determining whether a particular activity should be considered to constitute a business and in determining the tests to be applied in reaching such a determination.

There are many decided cases that consider the issue where the potential outcome is between 'business or hobby’ or 'employee or independent contractor’ (with an independent contractor being considered to carry on a business). In this case, we are considering the question of 'Are you carrying on a business’ with the other potential outcome being that the activity constitutes an investment that generates assessable income.

In Administrative Appeals Tribunal (AAT) case of YPFD and FCT [2014] AATA 9 (YPFD case), the following statement about the tests that are relevant when the issue involves residential rental properties was made:

16. The Tribunal suggested in Shields v Deputy Federal Commissioner of Taxation (1999) 41 ATR 1042 and, more recently, in Smith and Commissioner of Taxation (2010) 79 ATR 934, that relevant matters might include:

(a) the nature of the activities and whether they have the purpose of profit-making;

(b) the complexity and magnitude of the undertaking;

(c) an intention to engage in trade regularly, routinely or systematically;

(d) operating in a business-like manner and the degree of sophistication involved;

(e) whether any profit/loss is regarded as arising from a discernible pattern of trading;

(f) the volume of the taxpayer's operations and the amount of capital employed by him; (by 'her' in the present case).

Nature of the activity

In strict legal terms, a lease is a contract where one party (the landlord) conveys exclusive possession of some property to another party (the tenant) for a period in exchange for some form of consideration without there being any intention that the tenant will buy the property during or at the end of the period.

The consideration is payable to the landlord as owner of the property and not in respect of any other activity undertaken or provided by, or on behalf of the landlord.

In such cases, the landlord would continue to have the obligation to pay ownership expenses in relation to the property and would generally be expected to incur expenses to maintain the property in a state consistent with the requirements of the lease contract.

Generally, lease contracts would be expected to run for longer periods of time.

This contrasts with shorter term contracts where the tenant might only be provided with a right to occupy premises and not exclusive possession. It is significantly more common in shorter term cases that the consideration will then also contain components in respect of specific services provided by the owner such as meals or cleaning.

You have long-term stable tenants and long-term lease contracts regulating the relationship between the parties. The payments you receive relate solely to the use of the properties by the tenants and do not relate to any services that you provide to them.

Intention of the taxpayer

The carrying on of a business is not merely a matter of intention alone. Rather, it is a matter of activity motivated by intention. It is appropriate to look objectively at the activity (including when it started) to reach conclusions about a taxpayer’s state of mind in deciding to conduct the activity.

Both business and investment will have a profit making intention whereas a hobby will not. Strategies that minimise the costs of pursuing a hobby will not amount to having a profit making intention.

In general terms, a business activity will be seeking to more efficiently allocate resources than a mere investment and will seek to conduct the activity in a way that provides a return that is higher than the investment levels received by others conducting similar activities. A business may seek to adapt to changing circumstances by altering the form or nature of the allocation of those resources. A business may be seen as being more open to taking risks to pursue these outcomes.

Your properties have been used in the current manner for an extended period of time without there being any significant changes undertaken to enhance your returns. You are responsible for keeping the properties in a fit state of repair, but do not provide any direct services to the tenants.

Prospect of profits

The taxpayer's involvement in the activity should be motivated by wanting to make a 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.

Your properties have been negatively geared during large parts of your ownership period which is indicative of taking a longer term view and seeking a lower overall profit that is more reflective of investment.

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 comparison to some rental property owners, your daily involvement is minor. Given the activities of other property owners who are considered to be carrying on a business of letting properties it could not be concluded the level of repetition and regularity of your activity is the same.

We are looking at those activities that would be required in the renting of properties. If there was a block of 30 holiday units rented on a short time basis there is an extensive amount of work conducted on a daily basis in meeting tenants, providing and cleaning linen and other services. The fees paid by the tenants are for both the services and the use of the property and if it is of sufficient scale, because of the regularity of these services it can be argued that they could be carrying on a business of renting properties.

Your property activities are of a different nature to this. Your lease periods are of a longer time frame.

The level of repetition and regularity of your activities is not as great as that noted in Case 26 where despite the management and maintenance activities undertaken, the property owners were not considered to be carrying on a business of letting properties.

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 whose activities constitute a business, 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 other businesses, further support is given to the fact that a business exists.

Generally, where the property owners grant exclusive possession of the 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.

Your activity is renting out the X residential properties at market rates. This is similar to many other rental property owners who hold their properties as investments. Hence the relationship in respect of this test is indicative of a landlord and tenant.

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.

However, it is also reasonable to expect anyone investing in rental properties, including passive investors, to keep records in relation to their rental property/ies so that they can keep informed as to whether or not they are making a profit in relation to the rental property/ies and to make decisions as to what activities to undertake in relation to their rental properties to maximise their returns.

It may be arguable that rental property businesses might keep more detailed records than mere investments so that they can be better positioned to take advantage of opportunities that arise.

This test is more relevant when the potential alternate outcome is that the activity constitutes a hobby. Your activity does not have the nature of a hobby.

The size and scale of the activity

When considering this factor, we are looking at the scale in terms of the number of properties and what management input that may be required to conduct the activity.

Where size and scale is a relevant factor, the activity should be large enough to make it commercially viable as a business. 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.

You have rented out X residential properties. As stated above, whether an activity of letting of property amounts to the carrying on of a business will depend on the circumstances of each case as noted at paragraph 5 of Taxation Ruling IT 2423.

The scale of your activities and volume of operations can be distinguished from the cases noted above as there were only X properties.

Hobby or recreation

The activity does not have the nature of a hobby or recreational pursuit.

Significant commercial purpose

The 'significant commercial purpose or character' indicator is closely linked to the other indicators mentioned above 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 own X properties. Most were purchased some time ago. The properties are leased out for longer periods to stable tenants.

You received about $40,000 per year as rent from these properties. Expenses were about $55,000 per year leaving a net loss of about $15,000 each year.

The expenses are the traditional ownership expenses that would be incurred by any landlord. The level of the return from the activity appears to be consistent with other forms of investment given your situation.

You have not undertaken any strategies to increase the return received from the funds ventured into the activity or to enhance the efficiency of the utilisation of the ventured funds.

You are not subject to any additional risks or receiving any additional rewards over and above those borne by any traditional landlord.

Conclusion

After weighing up the relative business indicators and objective facts surrounding this case it is considered that you are not carrying on a business of letting rental properties.

Your case can be distinguished from Cripp’s case as in that case the scale, being 16 townhouses, was far greater than in your X properties. Despite the fact that 16 townhouses were rented the AAT found that the taxpayers were mere passive investors and not in the business of deriving income from rental properties.

Similarly in Case 26, despite the scale of operations of 22 units, the AAT found a business was not being carried on by the owners of the block of flats. Again the quantity of rental units is far in excess of your X properties.

Also, your circumstances are not similar to the examples provided in the Rental Property guide as outlined above.

Your properties are rented out for long periods to long-term stable tenants. The relationship between you and the occupiers of the properties is that of a landlord and tenant; where the tenants have exclusive possession and control access to and from the properties.

The undertaking of managing and maintenance, level of involvement, scale of activity and volume of operation in your activity is not as great as that noted in Case G10. We consider your case to be aligned closer with the circumstances in Case 24 and Case 26. Your activity lacks the repetition and regularity that is expected of a person carrying on a rental property business.

The overall management of your rental properties is similar to other rental properties managed as a passive investment. The types of records and tracking for a rental investment would be similar for both a passive investor and someone carrying on a business of letting rental properties given that rental income and expenses need to be recorded and property analysis reports and financial rations would be useful to invest further, or make any decisions about the performance of the rental property/ies.

There is no evidence to suggest that you are seeking to implement alternate strategies to increase or enhance the returns received from the properties that may be suggestive of a business-like intention or that there are opportunities for any such strategies.

Based on the information and documentation provided, it is the Commissioner’s view that your rental property activities are better described as leasing residential properties to receive passive income from a stream of rental income. The income is not derived from any services you provide directly to the tenants, but as owner from the letting of the properties.

In short, there is nothing special about the manner in which you conduct your rental activities that transform those activities from an investment into a business.

Accordingly, it is the Commissioner’s view that you are not carrying on a business of letting rental properties. Instead, the activity is undertaken as a passive investor in respect of a number of rental properties.

Question 2

Summary

The rental properties are not active assets for capital gains purposes.

Detailed reasoning

One condition for eligibility to treat an asset as an active asset is that you must be used in carrying on a business. Another condition is that the asset is not mainly used to derive rental income.

For the reasons outlined above:

● you are not using the rental properties in a business, and

● you mainly use the rental properties to derive rental income

Therefore you are not eligible to treat the rental properties as active assets.

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