Edited version of private advice

Authorisation Number: 1051532081861

Date of advice: 21 June 2019

Ruling

Subject: Am I in business? - rental properties and deduction - travel expenses

Question 1

Are you carrying on a business of letting rental properties?

Answer

No

Question 2

Can you claim a deduction for travel expenses incurred in owning residential rental properties?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are retired.

You currently have X properties which are rented.

You have sold properties with the intention of acquiring better quality properties with higher rental returns.

X of the X investment properties you own are managed by a property manager.

The services the property manager provides for the four properties are:

·         Advertising for tenants

·         Vetting potential tenants

·         Collecting rent and remitting rent to the property owner

·         Liaise with property owner/tenants on maintenance issues

·         Prepare and negotiate lease agreements

·         Property inspections when required

The property manager is paid a commission of approximately X% of gross rent.

The properties, with exception of "H", are typically leased for six to twelve month periods. Leases are generally renegotiated with existing tenants at the end of the lease period.

H is a short term holiday rental, which you self-manage. H is a self-contained unit which is located at your main residence.

You advertise and source your bookings for H using a holiday home booking website.

X of the X investment properties you own are managed by you.

The services you provide for the X properties are substantially the same as those provided by the property manager.

The activities you provide in relation to the properties occupy approximately XX hours per week.

You carry out the repairs and maintenance on all the properties as required, engaging licenced contractors where required for the scope of work.

You travel to location B to attend to maintenance and repair issues a couple of times a year. In your absence you engage a builder in location B to attend to the maintenance and repair of your location B properties.

You have a fully equipped workshop at your main residence and you have acquired vehicles for transporting goods, materials, tools, equipment, garden waste and rubbish to and from your properties.

You maintain a property ledger, supplier receipts, purchase receipts, property manager statements, bank statements, loan statements and photographs of damage caused by tenants.

You pay all outgoing expenses in relation to the properties.

Your intention has been to build a property portfolio that will provide you with sufficient income now and in your future retirement and to reduce debt, becoming a self-funded retiree. Your intention is to hold the best performing properties with the least amount of maintenance required in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1997 subsection 26-31(1)

Reasons for decision

Summary

Based on the information and documentation provided, you are not carrying on a business of letting rental properties and are a passive investor with a number of rental properties.

Whilst we acknowledge your circumstances, under section 26-31 of the Income Tax Assessment Act 1997 (ITAA 1997) travel expenses incurred in owning residential rental properties are not deductible.

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.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from 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.

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 and the repetition and regularity of your activities.

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 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? 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.

Paragraph 13 of TR 97/11 states that the courts have held that the following indicators are relevant in determining whether a business is or is not being carried on:

·         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.

No one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). 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 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).

In Rental Properties guide 2018 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.

Example 3 on page 6 of Rental Properties 2018 outlines a situation in which the owners are not carrying on a rental property business.

Example 3: Co-owners who are not carrying on a rental property business

The Tobin's own, as joint tenants, two units and a house from which they acquire 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.

Example 4 on page 6 of Rental Properties 2018 outlines a situation in which the owners are carrying on a rental property business.

Example 4: Is it a rental property business?

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.

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 that is characterised as passive income.

In the context of considering the above authorities and factors, the following general observations of the arrangement can be made:

·         All rental properties you own, with the exception of H, are leased out at market rates for the period of six to 12 months and are renegotiated if the tenant has advised they wish to stay in the property. This diminishes the level of repetition and regularity of activities needed to be considered a rental property business.

·         You manage X rental properties yourselves, with the other X being managed by a property manager. You are undertaking an active role in managing the rental properties however you still employ the services of a property manager to oversee X of the rental properties you own.

·         You conduct all services to the X rental properties you manage.

·         You undertake most of the general repairs and maintenance activities yourself on all properties and estimate you spend approximately XX hours per week on these activities.

·         You receive the rental income from your properties.

·         You have loans which were used to purchase the rental properties.

·         You maintain records of your rental property operations

·         The activity does not have the nature of a hobby or recreational pursuit. The nature of the activity is similar to other rental property owners who are actively involved in some aspect of the property/s they own.

·         You currently have no work other than attending to your rental investment properties.

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.

This case can be distinguished from Cripps case as in that case the scale, being 16 properties, was greater than the properties currently held by you. Despite the fact that 16 properties 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 in excess of the properties you own.

Your circumstances are not similar to example 4 in the Rental Property Guide 2018 as outlined above. The additional activities you undertake such as carrying out repairs and maintenance, organising tradesman for repairs and overseeing your real estate agents are not considered day-to-day business activities. Further your situation differs from the facts in example 4 in that you only manage X of your properties, and the example has 26 properties that are managed.

It would be reasonable to expect any property owner, either in general or a passive investor, to undertake any repairs and maintenance they have the capacity to undertake so that they do not have to engage the services of tradesmen. The undertaking of the repair and maintenance activities does not change the character of the rental property activities from investment to business.

Although you have provided that one of the properties, H, is rented as a short term (nightly or weekly) holiday rental; the remaining X properties are rented under lease agreements which are long term in nature. Also, given the period of the leases, the need to find new tenants or renew the existing leases could not be viewed as needing to be undertaken on a frequent basis, given the number of properties that you own.

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.

As you rent your properties on a long term basis, except for the Hide, you are not undertaking activities to the extent of those undertaken by the taxpayer in Case G10, who was actively involved with 6 units on a daily basis, and undertaking most of the activities arising in relation to the units himself, with the assistance of his wife.

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

Given the number of properties owned and the day to day activities of other property owners who are considered to be carrying on a business of letting properties it could not be concluded that the scale of your operation and the level of repetition and regularity of your investment activity is the same.

Based on the information and documentation provided, 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 the services you provide, but from the letting of the properties.

Accordingly, you are not carrying on a business of letting rental properties and are a passive investor with nine rental properties.

Travel Expenses

Subsection 26-31(1) of the ITAA 1997 states you cannot deduct a loss or outgoing you incur to the extent that it is related to travel, if it is incurred to gain or produce assessable income from certain uses of residential premises as residential accommodation. Section 26-31 of the ITAA 1997 applies to travel expenses incurred after 1 July 2017.

Travel expenses are the costs of travel, accommodation and meals, to inspect, maintain or collect rent for the property. As you are not carrying on the business of letting rental properties, subsection 26-31(1) of the ITAA 1997 denies you a deduction for travel expenses incurred in owning your residential rental properties.

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