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Ruling

Subject: rental income derived by life tenant

Rental property - tenant in common - deceased estate

Question

What is the correct apportionment of income and expenses relating to a rental property that is part of the estate of a deceased person, where one tenant-in-common has the full use and enjoyment of the entire property for a specified period of years?

Answer

100 percent of the rental income is assessable to the life tenant. However, the income is split and shown 50/50 between rental income assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), and a distribution from the estate which is assessable to XXX under section 97 of the Income Tax Assessment Act 1936 (ITAA 1936).

100 percent of those expenses which are allowable deductions under Division 8 of the ITAA 1997 are claimable by XXX. The trustees are not eligible to claim deductions against property income, in view of XXX's responsibility under the will for all property outgoings.

This ruling applies for the following periods:

Income years ended 30June 2011 to 30 June 2015.

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The deceased held a residential property ("the property") as a principal place of residence.

At the date of death the property was held by the deceased and their partner (XXX) as tenants-in-common.

An historical title search showed the following:

· The property was held as joint tenants by the deceased and XXX from the date of acquisition by them.

· A transfer was registered with the Registrar of Titles, changing their ownership interests to tenants-in-common in equal shares.

· Following the deceased's death a transmission by death was registered, showing XXX as a tenant-in-common over 50 percent, and the deceased's executors as joint tenants-in-common over the remaining 50 percent.

Will

The deceased's will was made prior to transfer of the ownership interests. Probate on that will was granted.

The will named two individuals as executors.

The relevant Clause of the deceased's will provided as follows:

The deceased's share in the principal residence owned by jointly by the deceased and XXX at the deceased's death upon trust:-

1. To permit the said XXX to have the use occupation and enjoyment of it during the certain number of years from the date of death of the deceased them paying all rates and taxes and other outgoings thereon and keeping the same in a good and habitable state of repair fair wear and tear and damage by fire flood earthquake and other inevitable accident excepted and them keeping the same insured against fire and earthquake.

2. Allow the trustees at the request of the said XXX to sell the said residence and to employ the deceased' share of the proceeds of sale in the purchase or erection of another residence to be held upon the same trusts including the trust for sale and erection or repurchase as are herein declared in respect of the original residence.

3. On the death of the XXX or the expiration of the specified number of years from the date of the deceased's death which ever is the sooner the said residence or proceeds of sale thereof shall be applied as follows:

· If the said XXX is then living then for XXX a share in the total value of the residence (such share including any interest of which they may be recorded as or deemed to be the legal owner);

· The remaining share in the total property for the deceased's children as are living at the deceased's death and if more than one in equal shares PROVIDED THAT if one of the deceased's children die before the deceased leaving a child or children, then such child or children shall take the share that their parent would have taken had he or she survived the deceased.

The property is rented at arm's length, through a real estate agency, to non-related tenants.

The total rent is being received by XXX.

A mortgage is held in the names of the estate of the deceased and XXX.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 6-5

Income Tax Assessment Act 1997, section 8-1

Income Tax Assessment Act 1936, section 97

Reasons for decision

Summary

In accordance with the terms of the will XXX is entitled to derive rent from the property. XXX would be assessed on 100 percent of the gross rental income received. However, that income will be received and dealt with as follows:

· 50 percent of the gross rent will be received and shown in XXX's income tax return as rental income, and

· 50 percent of the gross rent will be received and shown in XX's income tax return as a distribution of trust income.

Consequently, the trustees are required to show as trust income 50 percent of the rent received by XXX. This is because XXX has the legal interest in the rent attributable to their 50 percent tenancy holding.

Similarly, in accordance with the terms of the will, XXX is responsible for all outgoings relating to the property. The trustees are not entitled to deductions for property outgoings for their 50 percent tenancy because the will has removed their liability for such outgoings.

Detailed reasoning

The ruling application argues that XXX's equitable interest in the property does not follow their legal interest, and consequently the income and expenses of renting the property should be attributed 100 percent to XXX.

We assume that the outcome sought is that XXX would declare all the rent received as rental property income, and that none of the income is considered to be a trust distribution.

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or loss between co-owners, paragraph 38, is cited in support of that proposition.

TR 93/32 goes on to state that cases where the property title includes the name of a person who is a nominee or trustee must be decided on an individual basis, on the evidence available to establish that the equitable interest differs from the legal title (paragraph 40).

Paragraph 41 of TR 93/32 states the ATO view that there are extremely limited circumstances where the legal and equitable interests are not the same. The assumption is that where taxpayers are related, e.g. in marriage, the equitable right is exactly the same as the legal title. The ruling refers to the High Court of Australia case Napier v. Public Trustee (Western Australia) 32 ALR 153 ("Napier") as illustrating an example of equitable interest being different from legal title.

In Napier the appellant (Napier) was in a de facto relationship with the deceased (Evans). They lived in a house owned by Napier. Napier entered into a contract to buy another house and paid a deposit for it. After entering into that contract he discussed the purchase with Evans. The balance of the purchase price was paid by Napier and pursuant to his direction the property was transferred to Evans, who had not contributed to the purchase monies. After that the property was rented and the rent collected by Evans, who also paid the rates and other outgoings. Although the terms of Evans' will were not put before the Court, it was apparent the property in question did not pass to Napier on her death.

The judgement of Aicken J (accepted by the majority) sets out part of the cross-examination of Napier, and the details of the discussion referred to above were accepted by the Court. At the time of purchase it seems that Napier was ill and not sure of his continued good health or longevity. It was apparently agreed between them that the property would be hers as long as she lived and would then pass back to Napier (or 'the family', as he referred to it, being his sons). She was to have it 'for life', not 'absolutely'. Evans apparently agreed to this and she indicated that a codicil would be added to her will to confirm that intention with regards to the property. She did not make another will.

Napier argued that a resultant trust in his favour was created; or, in the alternative, that a constructive trust was effected. The Court concluded that the presumption of advancement in respect of a husband's dealings with a spouse was rebutted by the state of the law at the time, where the presumption of advancement did not apply in respect of dealings in favour of a de facto wife. There was no resultant trust operative in respect of the property during Evans' lifetime.

The submission of constructive trust was not considered by the Court, in view of its ultimate finding.

The Court accepted that the arrangement was that title to the property was to be recovered from Evans at her death. It was not accepted that the intention of Napier was that the entire beneficial interest should go to Evans. He retained his equitable interest in remainder expectant on the on the death of Evans and when that occurred his interest became absolute.

Mason J states in his judgement that

...the presumption that there was a resulting trust as to the entirety of the house property was only partly displaced, namely, by evidence of intention that the deceased was to have the property during her lifetime only. The consequence is that the appellant was entitled to an equitable estate in remainder and that on the deceased's death his estate became absolute.

In this ruling application the terms of the will are quite clear. The will allows XXX use, occupation and enjoyment of the property for a certain maximum period of time. Although not specifically stated in the will, use of the property includes the ability to rent the property to another person.

Clearly, XXX will be assessable on 50 percent of the rent received, since that percentage is in respect of XXX's legal share in the property, as a tenant-in-common. The will cannot affect XXX's 50 percent interest in the property.

Regarding the 50 percent attributable to the share held by the trustees, the legal interest of the trustees would attribute the rent received by XXX as being rental income of the trust, as legal owner. The trustees would agree that the property may be rented to unrelated parties. The trustees would be under a trust duty to ensure that rent owed to the estate is collected and the property properly maintained.

Regarding expenses, XXX is responsible under the terms of the will for all rates, taxes and other outgoings, including necessary repairs and maintenance, during the specified period that the estate property is used by XXX.

At the end of the specified period, the legal ownership of the whole property, or the proceeds of its sale, will be apportioned according to the will between XXX and the children of the deceased. Should XXX predecease the children XXX's half-tenancy of the property would be dealt with under the terms of XXX's will (or intestacy, if there is no will). The will does not provide for XXX to gain either or both shares attributed to the children should they predecease XXX. Hence, XXX does not have an interest in the whole property. XXX's equitable interest in the whole property does not exceed the legal interest.

Therefore we consider that XXX does not have an equitable interest in the property beyond their legal interest. Hence, the provisions of TR 93/32 apply and income must be dealt with on the basis of XXX's entitlement to income only, and the terms of the will regarding use of the property, and the obligation under the will to meet outgoings.

No detailed information about the mortgage held over the property was sought, such as the type of mortgage (whether it is a reverse mortgage, for example); the terms of the mortgage; and the date it was taken out. We consider that this does not affect the outcome of this ruling.

However, in the event the rental expenses exceed XXX's rental income and XXX's other financial resources, it might fall to the Executors to make up the balance. An example would be if insufficient income existed to pay the mortgage or other expense(s) requiring an outlay of cash (as opposed to deductions claimable for non-immediate cost items such as depreciation).