Edited version of private ruling

Authorisation Number: 1011650381351

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Ruling

Subject: Rental property expenses

1. Will the amounts you will receive from renting your share of the property to your parent be assessable income?

Yes.

2. Will you be entitled to a full deduction for your share of the expenses relating to the property?

No, the amount of your deduction will be limited to your share of the income received.

3. If the property is rented at arm's length to a person outside of the family, will you be entitled to a full deduction for your share of the expenses relating to the property?

No, the amount of your deduction will be limited to your share of the income received.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

Your parent inherited a share of a property.

They cannot afford to buy out the other share of the property.

You and your siblings intend purchasing the other share of the property.

In order to have exclusive control of the property as a holiday home, your parent will pay the portion of the market rate of rent attributable to the share of the property that they do not own.

The market rate for a property in the area is approximately $X per year.

You estimate that the property will cost approximately Y.

You state that the value is in the land and not in the house. You further state that the house is very run down and the purpose of buying the property really is that in the future the land will be valuable as prime development land because of its position.

It is possible that you will be invited onto the property on some occasions.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

Rental receipts are considered to meet the ordinary definition of income. Therefore, your share of the rent received forms part of your assessable income.

However, it is clear that the ultimate motive for purchasing the property is not to produce assessable income from rent. Therefore, the deduction for your share of the expenses is limited to your share of the income received.

Detailed reasoning

Rental income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes all ordinary income derived directly or indirectly from all sources. 

Rental income is considered ordinary income for the purposes of section 6-5 of the ITAA 1997 and is therefore assessable.

Expenses

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Generally, rental property expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature.

If the money is borrowed for the purpose of, or applied in, producing both assessable and non-assessable income, rather than producing only assessable income, the interest expense may need to be apportioned (see Ronpibon Tin N.L.Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236 (Ronpibon Tin) and Kidston Goldmines Ltd v. Federal Commissioner of Taxation (1991) 30 FCR 77; 91 ATC 4538; (1991) 22 ATR 168). This is a question of fact.

Regarding apportionment it has been stated (Brennan J in Ure v. FC of T 81 ATC 4100; (1981) 11 ATR 484)

If the borrowed moneys had been laid out solely for the purpose of gaining assessable income, the interest would be wholly deductible; but as they were laid out in part for that purpose, and in part for other purposes, the interest charges must be apportioned.

While the cases above discuss interest, the principle can be applied equally to other expenses.

Taxation Ruling TR 95/33 considers the deductibility and apportionment of losses and outgoings where expenses are incurred for dual purposes. TR 95/33 states that if an outgoing produces an amount of assessable income greater than the amount of the outgoing, there would normally be no need to examine the taxpayer's motives and intentions when determining the deductibility of the expenditure.

However, if the outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure to determine whether the outgoing is wholly deductible. This may, depending on the circumstances of the particular case, include an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing.

If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective, then the outgoing must be apportioned between the pursuit of assessable income and the other objective: see Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's Case)

As explained in Ure's case and Fletcher's case, in determining the deductibility of expenses it is necessary to consider the motive/purpose in incurring the loss/outgoing.

You have indicated that you wish to purchase a share of the property as your parent could not purchase it on her own so that your parent can have full access to it for holidays. You state that the rent that your parent would pay you is market rate for the area but it is not the house that makes the property valuable but the land. You also stated that the property will be very valuable in the future as prime development land because of its position.

Consequently, if the immediate or direct object intended to be achieved from the outgoings is not the production of assessable income which is commensurate with the outgoing, it will be necessary to determine if the expenses associated with the rental property can genuinely be characterised as outgoings incurred in gaining or producing assessable rental income

It is clear from your statements that the ultimate motive for purchasing the property is not to produce assessable income from rent. The disparity between what would normally be expected for a property purchased at the price you estimate and the amount you will receive as rent is far too great to indicate that your purpose was for gaining or producing assessable rental income. This is also supported by your statement that the value of the property is in the land and not the house.

Therefore, any deduction for the expenses you will incur will need to be apportioned to reflect your ultimate purpose.

When it is necessary to apportion a loss or outgoing, the appropriate method of apportionment will depend on the facts of each case. However, the method adopted in any particular case must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin). In Fletchers Case, it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year.

Taxation Ruling IT 2684 considers the circumstances in which interest on money borrowed to acquire units in a property unit trust is an allowable deduction. In that Ruling, the Commissioner considers that, in general, interest expenses incurred on borrowed funds used to purchase income units, capital growth units or combined units (units offering returns of both income and capital growth) are an allowable deduction. However, the Commissioner considers that there are exceptions to the general rule.

Your case is somewhat analogous with a capital growth split property unit trust, in which the investor is entitled primarily to capital growth, but which may also produce some assessable income.

The Commissioner's view with respect to capital growth split property units is that where such units are expected to produce only negligible income, interest expenses incurred in borrowing money to purchase the units are deductible only up to the extent of the assessable income actually received.

Having regard to all the circumstances, it is considered fair and reasonable to adopt the same approach in your case. Therefore, a deduction for expenses relating to the property will only be allowed up to your share of the rent received.