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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your written advice

Authorisation Number: 1051435553684

Date of advice: 5 October 2018

Ruling

Subject: Carrying on a business – rental properties

Question:

Do your activities in relation to your rental properties during the 20XX-XX income year constitute a carrying on of a business?

Answer:

No.

This ruling applies for the following period

Income year ending 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

Background

You were awarded a diploma which you have used in relation to your properties and became a member of the relevant institute.

You registered for an Australian Business Number (ABN) as an individual/sole trader, with the trading name.

You purchased a number of properties prior to the 20XX-XX income year which were acquired for a number of reasons, such as:

You renovated and subsequently sold a property during a number of the following income years up to the 20XX-XX income year which involved getting council permits, finding local contractors, having discussions with local real estate agents to understand what buyers are seeking in the local area and gaining preliminary valuations before commencing the renovations.

A number of the properties were held for over nine years before being sold with a profit being made on their sale. Other properties were held for less than five year, with a loss being made on their sale.

Properties held during the 20XX-XX income year

You acquired various ownership interests in a number of properties as follows which you held during the 2017-18 income year:

Property sold during 20XX-XX income year:

Property A - 100% Ownership interest

Reason purchased - Property in good location, under median price for area, located on a good sized block with potential for future development which met your Business Strategy at that time. The Property was rented out since it was purchased and was the poorest quality property in the portfolio.

Houses in the local area increased a number of years after the property was acquired due to a combination of an upturn in the local tourism and the opening of major infrastructure in the nearby area.

Sold during 20XX-XX income year for a profit.

Properties held during the 2017-18 income year:

Property B - 100% Ownership interest

Initial loan amount has been reduced to around ¼ of the original amount borrowed.

The property has been held for more than ten years. The market value of the property has increased by more than 40% since it has been held.

Reason purchased - Purchased to fit your Business Strategy at that time.

Improvements - You built a covered patio area in first year to improve rental returns and future capital value. You have recently spent several thousand dollars replacing carpets, blinds and rebuilding side fence. Rent will be increased this year.

Future plans - To hold and continue to rent for the next few years. Has excellent current tenants who have advised that they wish to stay for a number of years.

Property C - 50% Ownership interest

Initial loan amount borrowed has not been reduced at this point.

Purchased a number of years ago. Market value of property has increased by around 1/7th of the market value of the property since it was purchased.

Reason purchased - Large property with large land area.

Located within walking distance of a major city’s waterside, close to major city central business district and airport. Under median price for that area. Better quality than previous purchases. It fits in with your revised strategy of having higher quality properties.

Future plans - This will most likely be the next property to do major redevelopment and/or renovations and sell it for a profit. It is currently in Hold phase while waiting for the market to take off.

Property purchased during the 20XX-XX income year

Property D - 50% Ownership interest

Market value of property has increased slightly since it was purchase during the 20XX-XX income year.

Reason purchased - Purchased to fit your Business Strategy. Situated in good location, with large block with potential for future development.

Has a quality larger house located on it with longer than normal road frontage, which provides options for future development when the market has increased over time.

Purchased under the median price for area. Providing good rental return.

Future plan – Property is still in Hurt phase. You have negotiated an increase in rental recently, with a further anticipated rental increase in the future to make it almost cash flow neutral. You intend to continue to hold it and rent it out for several years.

Property activities

You engaged the services of a real estate agent (the Agent) to manage the properties you owned during the 20XX-XX income year.

The Agent undertook the following letting and management activities:

The properties leases are normally for either X to XX months duration.

The tenants are asked to contact the property manager as the first point of contact in relation to issues with the properties, who will contact you about maintenance issues. You will either undertake the work when possible, or engage the services of professional tradesmen.

You undertake all of the outside yard work, and most handyman work in addition to some plumbing. You do not do any electrical work. You have undertaken various activities in relation to fixing, replacing and improving your properties in the past such as painting, fixing showers, dripping taps, paving, fixing roof leaks, re-hanging doors, fixing locks, drawers, pruning and gardening, fixing damage to walls such as cracks and other plaster work, replacing blinds, curtains and fly screens, concreting, windows and flooring.

You schedule the work for every few months, unless the issue is dangerous or urgent, and address them when you are visiting the properties.

You have a shed located in each state that the properties are located in which you keep tools, ladders and materials used in relation to the maintenance of the properties.

You have a caravan that you tow behind your work ute and stay in local caravan parks while you are working on the interstate properties. While in the area you inspect other properties.

You estimate that you spend on average more than 20 hours per week on your properties as follows:

You normally spend a number of days during the months leading up to the renovations which can include a combination of your labour and you obtaining and managing contractors on site, with average hours per renovation estimated to be less than 200 hours.

You normally spend a week cleaning and touching up the paint work after the tenants move out.

You engage a real estate agent to sell the properties, with you being on call, estimated time involved being less than 100 hours.

During the 2017-18 income year you travelled to the interstate properties on a number of occasions to:

In addition, you organised for tradesmen to address issues at the properties, inspected potential properties, dealt with solicitors in relation to the sale of a property and visited your bank in relation to refinancing issues.

You had dealings with a number of real estate agents with whom you are in contact with regularly, and from whom you receive newsletters and updates on market trends, some of which you have had dealings with for many years.

You keep a separate bank account that you use for your property activities.

You keep a filing cabinet in your home office and have a separate filing drawer for each of your properties in which you keep relevant documentation such as invoices, receipts and important documentation. You keep the files for each property for at least five years after the property has been sold.

You keep separate folders on your computer in relation to each property in which you keep emails relevant to that particular property.

You have registered and run your own domain and have a separate email address to keep your personal and/or family emails separate.

You pay for all of the council rates in relation to the properties. The liability for water rates varies from property to property with some tenants paying an excess amount per quarter, with other tenants being in the ‘water complaint properties’ where they pay the water rates.

You pay the electricity for some of the properties, with the tenant/s paying for their own electricity, depending on what has been agreed upon when the lease agreement was negotiated.

On average you worked less than 60 hours per month, or less than 10 days per month as an employee. During the 20XX-XX income year you earned $XX,XXX as an employee.

Property strategies

Your business strategy originally consisted of doing everything yourself, buying at the lowest price and then improving the property. You changed your strategy following the losses you made in relation to the sale of a number of properties prior to the 20XX-XX income year.

Your current business strategy consists of acquiring, improving and harvesting the properties using the following three phases which have a cycle time of X to XX years:

The actual timing depends on the property market cycles and the current conditions in each location. A property will normally have some renovation or development work before it is harvested to maximise its profit.

You normally have one property at the Hurt phase, potentially several properties in the Hold phase and one property in the Harvest phase.

Future properties

You anticipate expanding your property portfolio as you are currently holding significant cash and equity to allow that to occur. However, the property prices in a number of capital cities are currently too high to obtain a positive cash flow return.

You anticipate that there will be a drop in property prices and an increase in the average rents due to the extremely low yields at present. When the market changes you propose to buy in a capital city. You are still looking at potential properties to purchase in City A.

Rental amounts

You estimate that you received gross rent of $XX,XXX in the 20XX-XX income year, which included estimated rental income from Property D of $XX,XXX.

In previous income years you have recorded:

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Summary

You are not carrying on a business of letting rental properties. It is considered that the scale of activity and volume of operations carried on by you is insufficient to be considered as carrying on a business.

Detailed reasoning

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts. This ‘ordinary income’ includes amongst other things, income from salary and wages and business operations.

Section 8-1 of the ITAA 1997 allows you to claim a deduction for a loss or outgoing that is incurred in gaining or producing your assessable income, or necessarily incurred in carrying on a business to gain or produce assessable income. These deductions are limited by the exclusion of losses or outgoings that are capital, private or domestic in nature.

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'.

Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business.

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case. Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual.

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. This is because of the limited scope of the rental property activities and the limited degree to which an owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations.

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. The Tribunal also made the following observation about Taxation Ruling IT 2423:

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:

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. In reaching that conclusion, the Board found:

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:

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 2018 guide (Rental Properties guide) published by the Australian Taxation Office, it states the following at page 6:

The Commissioner sets out two examples in the Rental Properties guide 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.

Example 3 on page 6 of the guide, outlines a situation in which the owners are not carrying on a rental property business. The Commissioner states:

Example 4 on page 6 of the Rental Properties guide, outlines a situation in which the owners are carrying on a rental property business. The Commissioner states:

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 are 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.

We have made the following observations when determining whether your activities are the carrying on of a business:

Conclusion

After weighing up the relative business indicators and objective facts surrounding this case it is considered the information and documentation provided does not support that a business is being carried on in relation to your rental properties during the 20XX-XX income year.

Your rental property activities are better described as leasing residential properties to receive income from a stream of rental income in addition to holding the properties for significant periods to obtain the capital growth made on the properties during your lengthy ownership periods, plus incremental gains made to works undertaken on the properties prior to their sale.

The rental income is not derived from the services you provide directly to the tenants but from the letting of the properties.

Your properties are rented out for long periods to long-term stable tenants. There is no evidence to suggest that the properties are rented as short term (nightly or weekly) rentals; rather, they are rented under lease agreements which are typically long term in nature. 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.

During the 20XX-XX income year you held a number of properties, selling one, buying one, and holding two properties purchased in previous income years. As outlined in Case 26 above, 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. The quantity of rental units in that case is far in excess of your properties. Additionally, your circumstances are not similar to the examples provided in the Rental Property guide as outlined above.

The overall management of your rental properties is not dissimilar to other rental properties managed by an agent for a passive investor with the activities undertaken by the property manager in your case being of a similar nature to those undertaken in relation to properties owned by passive investors.

The types of records 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.

Your business strategy consists of ‘Hurt’, ‘Hold’ and ‘Harvest’ phases. You described the ‘Hurt’ phase as a period of no initial reward for a significant period of time, and that it normally takes several years before the negative cash flow becomes neutral. Additionally, when in the ‘Hold’ phase, the property should have neutral cash flow within a further number of years, becoming increasing cash flow positive over a number of years. Your business strategy is more indicative of an investment strategy and not a business strategy. Businesses will be seeking a business or commercial return from their properties and it is reasonable to expect that anyone carrying on a business, or owning investment properties, to be seeking a positive return from owning the property and not to be holding properties that are negatively geared.

It is a rare business that does not seek to maximise its revenue by maintaining its assets to an acceptable standard, and while not decisive, it is relevant. But in doing that, it does not mean that they have conducted their activities in owning and managing the properties in a manner that is business-like. It would also be reasonable for an investor to renovate their rental properties to earn higher rental income and/or appeal to a different tenant market. This may involve seeking advice from real estate agents as to what activities could be done to the property to increase its rental appeal and potential rental returns.

You undertook activities on your properties on a number of occasions during the 20XX-XX income year. The additional activities you undertake for the rental properties such as carrying out repairs, maintenance, organising tradesman and/or renovations are not day-to-day activities. Additionally, those activities are in relation to keeping the properties in a condition suitable for them to be tenanted, not in relation to services to the tenants.

Activities were undertaken on Property D after it was purchased to get it in a condition to be fit to be tenanted out. These activities are viewed as being capital improvements to the property. It is reasonable to expect that anyone purchasing a rental property, whether as an investment or as business trading stock, would undertake activities to increase the amount of rental income that the property would earn, or to increase its appeal to a better class of tenant.

You seek advice from real estate agents on what activities should be undertaken in relation to the properties on how to obtain a higher sale price when selling your properties, and undertake renovations and other activities to get the property into a condition suitable for sale. It would be reasonable that any prudent investor, or a general homeowner, would undertake those activities in order to gain the maximum sale proceeds from the sale of their property. The main profit you make on the sale of your properties is made because you have held them for lengthy periods, such as being owned for more than 10 years in the case of Property A. The profit from the additional activities you undertake are incidental to the gains made from holding the properties.

It would be reasonable to expect any property owner, either in general or a passive investor, to undertake any similar repairs/maintenance/renovations they have the capacity to undertake so that they do not have to engage the services of tradesmen in an endeavour to cut down costs. The undertaking of those activities by themselves does not change the character of your rental property activities from investment to business.

The rental returns you received in relation to the properties are merely from holding the properties. The net rental amount recorded during the recent income years has either been relatively low profits or low losses. It is viewed that the taxpayer’s involvement in the activity should be motivated by wanting to make a profit and their activities should be conducted in a way that facilitates this.

It is stated that Property C is currently rented out at above the median rent for the suburb based on information sourced from a website in the state in which the properties are located which provides median rental amounts for two periods each income year for a four bedroom, two car space house. Property C is a five bedroom house with two car spaces and it is therefore expected that the rental income received for that property is higher than the median rental amount as provided on the website.

Additionally, the average amounts of gross rent you reported in relation to Property A, B and C in the 2016-17 income year were not as high as the median amounts provided at that website for four bedroom houses with two carports.

It is outlined in the spreadsheet provided that you received gross rent of $XX,XXX in the 20XX-XX income year.

Based on the rental amounts recorded it is viewed that you have been earning moderate gross rental in relation to a number of your properties in previous income years which is of an investment level. Based on the information provided we are not able to determine whether you have made a loss or gain in relation to your properties during the 20XX-XX income year.

You undertook employment activities during the 20XX-XX income year but state that your main source of income was your property activities with a significant amount of capital gains having been declared over the past income years. The capital gains, or profits, made on the sale of the properties were made due to the length of time that you held the properties, in addition to incremental profits made as a result of your activities to prepare the properties for sale. It is not unreasonable to expect that property investors may sell their property/ies if their market value increased so that they could realise the profit arising from holding their property/ies.

Accordingly, it is the Commissioner’s view that you were not carrying on a business of letting rental properties in the 20XX-XX income year and were a passive investor with a number of rental properties.

Note: As you are not carrying on a business in relation to your rental properties you cannot claim any travel expenses incurred in relation to your rental properties.

Any building materials purchased in relation to the properties will be included in the relevant property’s cost base.

A deduction can be claimed for tools and other items acquired in relation to earning your rental income. However, a deduction cannot be claimed for tools and other items used in relation to other activities, such as renovations, as they relate to capital improvements on the relevant property.


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