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Ruling

Subject: Rental income

Question

Are you able to treat the property owned by you and your spouse , which is currently occupied exclusively by your spouse as a rental property and claim any associated expenses?

No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You and your spouse have a house which was your main residence up until your marriage break down.

This property was held in joint tenants and was changed to tenants in common when you separated.

Your spouse still lives in the home and you have moved out.

You and your spouse had a verbal agreement that your spouse would pay rent at half the market rate.

Your lawyer drafted an agreement for your spouse to sign saying that they would pay rent but they refused to sign it and consequently you do not have a written agreement.

Your spouse does not pay you rent.

You pay the mortgage on the property and associated costs.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (the Act) states that all losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income (or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income), shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income.

Rental income derived by the owner of property which is let to a tenant forms part of the owner's assessable income, and deductions are allowable for expenditure (which is not of a capital, private or domestic nature) incurred in gaining this income.

However, where the tenant is a co-owner of the property, payments made to the other co-owner will not necessarily be classified as 'rent'.

The question arises as to whether you are able to treat your former residence as a rental property when your spouse is a co owner and is still living in the property and not paying rent?

Co-ownership

Taxation Ruling TR 93/32 explains the basis upon which the net income or loss from rental property should be divided between co-owners. The ruling provides the following explanation of co-ownership:

"Ownership conveys an entitlement to exercise the maximum legally permissible rights over what is owned. Generally a legal interest in land is achieved by the owner being the registered proprietor of the legal title to the land. Where there is more than one person with a concurrent legal interest in the same land, those persons are co-owners of the land.

Co-owners of rental property will generally hold the property as joint tenants or tenants in common. These tenancies are a further classification of the co-owners' interests."

You and your spouse held the property as joint tenants up until you separated, the property was then changed to tenants in common.You are therefore co-owners of the property.

Taxation Ruling TR 93/32 states that co-owners of a property who are joint tenants of that property will hold identical legal interests in the property. That is, their interest must be the same in extent, nature and duration: eg, A and B, who each own an identical 50% share in a property, are, provided the other requisite features, are present, joint tenants of that property.

A joint tenancy is a common ownership of property in which all the co-owners together own the whole, each having an 'undivided' share. There must be unity of interest i.e. co-owners' interests in the property must be identical in nature, extent, and duration. Each co-owner has a right to each part of the property and to the whole, but not an exclusive right to possess any part. (With a tenancy in common, the co-owners also hold undivided shares, possessing the property in common and without exclusive possession of any part of it. However, the shares may be in different proportions).

Co-owners who hold property as joint tenants have an equal right to the property acquired jointly and there is no liability for one co-owner to pay occupation rent to the other as they already have a half share in the whole of the property by virtue of the fact that they are a joint tenant/owner. This point was highlighted in Case P76 82 ATC 362; 26 CTBR (NS) Case 8.

Where a taxpayer who co-owns a property with another occupies the house and pays an amount per week to the co-owner as 'rent', the amount paid by the taxpayer to the other co-owner is not in the nature of rent and is not assessable income to the co-owner recipient according to ordinary concepts. This is because the taxpayer as 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. Any payments made by the taxpayer to another co-owner in relation to that occupancy are not in the nature of rent (Luke v Luke (1936) 36 SR (NSW) 310) 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 (Luke v Luke and Scapinello v Scapinello [1968] SASR 316). As rent, any such payment is income according to ordinary concepts (Case R16 84 ATC 179; 27 CTBR (NS) Case 67). It is expected, in such a circumstance, that the parties would have entered into a bona fide lease agreement to establish that exclusive occupancy (Case P76).

Case P76

The issue of one co-owner paying rent to the other co-owner for exclusive use of the property was considered by the Board of Review. Case P76 clearly demonstrated that a co-owner can rent premises from a co-tenant for exclusive possession of the premises, but that a lease to achieve this result must be properly established.

In Case P76, the taxpayer and B owned a cottage as tenants-in-common in equal shares. B occupied the cottage and made monthly payments to the taxpayer, apparently 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 (ie. rent that would be acceptable for renting the whole property). It was agreed that B pay the taxpayer $108 per month. 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). Expenditures relating to the property were shared equally between the taxpayer and B. The taxpayer returned as assessable income the "rent" paid by B and claimed a deduction for outgoings. Before the Board the Commissioner contended that the "rent" was not assessable income but was rather a voluntary contribution towards the taxpayer's share of the outgoings. The taxpayer, who conducted his own case, did not call B as a witness to give evidence.

Held: by majority, claim disallowed. The taxpayer had not established that the payments were received by him as assessable income. Stevens, H.P. said:

"While 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 payment being assessable in the hands of the recipient, the existence of such a lease is not to be lightly assumed but must be properly established. In the present case the evidence was insufficient to spell out what were the terms and conditions of the alleged oral 'agreement' and it was not possible to find that the taxpayer had established a basis for holding that he was in receipt of assessable income by way of, or in the nature of, rent. It follows that he had also not established that the expenditure in question was incurred in gaining or producing assessable income."

Harrowell, J.R. said:

"Where no written tenancy agreement exists and the parties are tenants in common it is not possible to assume that one tenant in common is liable to pay an occupation rent to his fellow tenant in common solely on the latter's say so; they both must come forward and give evidence to that effect."

In considering the issue of whether there is a liability on one co-tenant to the other co-tenant to pay occupation rent, the Board of Review in Case P76 had regard to the authorities on the matter, and to various statements such as the following:

Lord Denning M.R. in Jones (A.E.) v. Jones (F.W.) (1977) 2 All E.R. 231, at p. 235:

"As between tenants-in-common, they are both equally entitled to occupation and one cannot claim rent from the other. Of course, if there was an ouster, that would be another matter; or if there was a letting to a stranger for rent that would be different, but there can be no claim for rent by one tenant-in-common against the other whether at law or in equity."

Lord Cottenham L.C. in M'Mahon v. Burchell 1 Coop., temp. Cott. 457 at p. 464 said:

"Where there was mere occupation the tenant-in-common was not liable for rent either at law or in equity. There must be either exclusion or some contract to make the occupying tenant-in-common liable."

In your case, in order for payments to be in the nature of rent, the existence of a lease (showing exclusive possession of the property upon the terms of the lease and therefore a liability to pay rent at the rate reserved by the lease) between you and the other co-owner must be properly established. It is necessary to establish that you and your ex-spouse entered into a bona fide lease agreement.

There was no written tenancy agreement or contract in relation to your ex-spouse's occupation of the property. You state that you and your ex-spouse had a "verbal rental agreement". The critical question for determination is the nature of the "agreement" between you and your ex-spouse.

Where no written tenancy agreement exists, it cannot be assumed that the other co-owner (your ex-spouse) was liable to pay an occupation rent to you solely on your say so.

Consequently you are not able to treat the property as a rental property for taxation purposes.