Edited version of private ruling

Authorisation Number: 1011664270050

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Ruling

Subject: rental expenses

1. Is the rent you receive from the co-owners of your rental property assessable income?

Yes.

2. Are you entitled to a deduction for your interest expenses on the money used in purchasing your share of the property?

Yes.

3. Are you entitled to a deduction for your one-third share of body corporate and rate expenses incurred in relation to the property?

Yes.

4. Are you entitled to a deduction for your share of the capital works deduction in relation to your ownership in the property?

Yes.

This ruling applies for the following period

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commenced on

1 July 2010

Relevant facts

You purchased a property.

The property was recently constructed.

You borrowed money to purchase the property.

The loan is in your name only.

The sole purpose of the loan money was to purchase the rental property.

You previously rented the property to relations for market value rent.

You have now transferred two-thirds of your interest in the property to your relations for market value.

The full proceeds were used to reduce your loan.

You and your relations now co-own the property as joint tenants.

Your parents continue to pay you one-third of the market value rent.

You pay for one-third of the expenses such as body corporate fees and rates.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Division 43.

Reasons for decision

Summary

As you own one-third legal interest in the property and the property is being rented at arms length, the associated income is assessable and you are entitled to one-third of the expenses.

Reasoning

Assessable income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year.

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

The Commissioner provides guidance on the issue of letting of property to relatives in Taxation Ruling IT 2167. Where 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 purposes from any other owner in a comparable arms length situation.

The ultimate resolution of the matter would depend upon the purposes of the taxpayer in acquiring the property and letting the property to relatives. For example, in FC of T v. Kowal 84 ATC 4001; (1983) 15 ATR 125, where taxpayers were renting to relatives at below market rate, the Court found that the taxpayer had two purposes or objectives 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. As such, deductible expenditure was restricted to the level of income derived.

In Case R16 84 ATC 179; 27 CTBR (NS) Case 67 the Board of Review held that one tenant in common can lease premises from their co-tenant in common (so as to have exclusive possession) and be liable to pay the amount reserved by the lease, and this amount is assessable income in the hands of the recipient. In such circumstances, the amount of rent being paid must be equal to that of a fully arms length transaction.

As outlined in Taxation Ruling TR 93/32 income and expenses from a rental property are generally shared according to the legal interest of the owners. That is co-owners must divide the income and expenses for the rental property in line with their legal interest in the property according to the title deed. If they are joint tenants, they each hold an equal interest in the property.

Therefore, where you rent the property to your relations under a commercial arrangement, the rental income derived in relation to your share of the ownership of the property will be assessable under section 6-5 of the ITAA 1997.

Deductions

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.

Specific deductions are deductions for specific kinds of expenditure that are allowable under provisions other than the general provision of section 8-1 of the ITAA 1997. For example, certain capital works deductions are allowable under Division 43 of the ITAA 1997.

Interest expenses

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible.

Interest on money borrowed by only one of the co-owners which is exclusively used to acquire that person's interest in the rental property is an allowable deduction.

In your case, you have a loan where the borrowed funds relate only to your share of the property. As the borrowed funds are being used for income producing purposes, the associated interest expenses are an allowable deduction.

Capital works

Division 43 of the ITAA 1997 allows a deduction for certain capital expenditure incurred in constructing capital works including buildings and structural improvements that are used for income producing purposes.

Subsection 43-25(1) of the ITAA 1997 provides that the rate of deduction for capital works which began after 26 February 1992 for a residential rental property is 2.5%. The deduction is allowable only for the period the property is rented or is available for rent.

In your case the construction of your property commenced after 1992 and qualifies as a capital works deduction under Division 43 of the ITAA 1997. Your allowable deduction will be one-third of 2.5% per annum of the cost of the construction.

Other rental expenses

Payments made to body corporate administration funds and general purpose sinking funds are an allowable deduction. Therefore, you are entitled to claim one-third of the deductible body corporate fees in relation to your rental property.

Rates and insurance are also an allowable deduction under section 8-1 of the ITAA 1997. You are therefore entitled to claim a deduction for your share of these costs.

Please refer to Rental properties (NAT 1729) for further details on allowable expenses in relation to your property. This booklet can be found on the Australian Taxation Office website www.ato.gov.au.