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Ruling

Subject: rental property rented by one of the co-owners

Question 1

Is the rent you receive from the co-owner of your rental property assessable income?

Answer

Yes.

Question 2

Are you entitled to a deduction for interest expenses incurred on money you borrowed to purchase your share of the property?

Answer

Yes.

Question 3

Are you entitled to a deduction for your share of expenses incurred in relation to the property?

Answer

Yes.

This ruling applies for the following period:

1 July 2011 to 30 June 2015

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You purchased a property.

You rented this property to tenants.

You borrowed money to purchase the property.

You sold a 50% share in the property to a family member.

You and the family member now co-own the property as tenants in common.

You used the proceeds from the sale to reduce the outstanding borrowings you had originally made to purchase the property. The remaining borrowings did not exceed 50% of the outstanding amount at the time that you sold half the property to the family member.

The family member now lives in the property and pays you rent equal to half the commercial rate that could be obtained if you both rented the property to an unrelated party in a fully arms length transaction.

Relevant legislative provisions

Income Tax Assessment Act 1997 6-5 and

Income Tax Assessment Act 1997 8-1.

Reasons for decision

Summary

As you own 50% of the property and you are charging your co-owner 50% of the commercial rental rate, the rental income paid to you by the co-owner is assessable income.

You are entitled a deduction for all of the interest incurred on the money you borrowed which was used exclusively to acquire your interest in the property.

You are also entitled to claim deductions for 50% of other deductible expenses incurred in relation to the property, such as rates, repairs and maintenance.

Detailed reasoning

An amount is assessable income if it is income according to ordinary concepts (subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997)). 

Rent derived by the owner of property which is let to a tenant is income according to ordinary concepts and forms part of the owner's assessable income.

A co-owner of a property has a common law right to occupy that property and, subject to the similar rights of the other co-owner(s), is under no obligation to pay an occupation rent to any other co-owner in relation to that right. Subject to the discussion that follows, any payments made by a co-owner to another co-owner in relation to that occupancy are not in the nature of rent and are not income according to ordinary concepts.

However, circumstances may arise where a co-owner seeks occupancy of the residence to the exclusion of the other co-owner. In such a case the excluded co-owner is entitled to an occupancy rent from the occupier. As rent, any such payment is income according to ordinary concepts.

In Case P76 82 ATC 362; 26 CTBR (NS) Case 8, the issue of one co-owner paying rent to the other co-owner for exclusive use of the property was considered. It was held that a co-owner can rent premises from the other co-owner for exclusive possession of the premises, but that a lease agreement to achieve this result must be properly established. It is not necessary that the lease be in writing, it may be an oral agreement (as in Case R16 84 ATC 179; 27 CTBR (NS) Case 67).

In Case R16; Case 67, the taxpayer and B owned a cottage as tenants in common in equal shares. B occupied the cottage and made monthly payments of $108 to the taxpayer, pursuant to an oral agreement. The agreement was that because they owned the property in equal shares, B would pay the taxpayer an amount equal to half an acceptable rent (the rent that would be acceptable for renting the whole property). The monthly payment figure of $108 was arrived at by taking half of the figure $216 (which was within $5 of the monthly rental being paid through an estate agent for a similar property). Pursuant to the oral agreement, in return for the designated payments the taxpayer yielded to B exclusive possession of the property.

It was held in the above case:

1. One tenant in common can lease premises from his co-tenant in common (so as to have exclusive possession) and be liable to pay the amount reserved by that lease - such payments by way of rent being income according to ordinary concepts and assessable income in the hands of the recipient.

2. Where an amount paid as rent is grossly disproportionate to what could have been expected to be paid in an arm's length transaction, an inference of benefaction could arise. However, in this case there was no gross disproportion or any element of benefaction. The parties arrived at an amount which they considered was the market rental value of the property and it was agreed that the taxpayer would be paid one-half of that amount.

In your case, you intend to rent the property to your co-owner in line with normal commercial practices. Consequently, the payments that will be made to you by the co-owner are payments by way of occupancy rent. As rent, the payments are income according to ordinary concepts and are assessable income in your hands.

As the rental income is assessable, you can deduct any loss or outgoing to the extent that it is incurred in gaining or producing that assessable rental income, except where the loss or outgoing is capital or private in nature (section 8-1 of the ITAA 1997)).

Taxation Ruling TR 93/32 provides that 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. However, 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 does not need to be divided between the co-owners.

Therefore, you are entitled to claim a deduction for interest expenses incurred on the money you borrowed to purchase your share of the property. You are also entitled to claim a deduction for your share (50%) of other expenses incurred in relation to the property, such as rates, repairs and maintenance.