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Ruling

Subject: Rental income and deductions

Questions:

1. Do the total expenses incurred for advice, application fees and valuation fees when purchasing your property form part of the property's cost base?

Answer:

Yes.

2. Are you entitled to a deduction for all your rental property expenses, including on-going fees?

Answer:

No.

3. Are you entitled to a deduction for a portion of your rental property expenses, including on-going fees?

Answer:

Yes.

4. Are you entitled to a full deduction for capital works and depreciation expenses?

Answer:

No.

5. Are you entitled to a partial deduction for capital works and depreciation expenses?

Answer:

Yes.

6. Can non-deductible amounts incurred for rates, insurance, repairs, maintenance and some interest payments be included in the cost base?

Answer:

Yes.

This ruling applies for the following period

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2011

Relevant facts

You entered into a services agreement with a business set up to supply rental homes. You incurred an initial fee of $X0.

You entered into a contract to purchase a house and land package in the 2011-12 financial year with the home being available for rent on in the same year.

At the time of settlement of the land, you incurred and additional application fee and a valuation fee to enter into the program.

Under the program you entitled to receive annual incentives, including a non-assessable non-exempt (NANE) payment.

You are charged an annual fee calculated at Y% of your incentive amount.

Entitlement to these incentives is subject to certain conditions being met by you, including that your rental property is rented to eligible tenants at an amount below market rates.

You will incur expenses in respect of the rental property, including insurance, repairs and loan interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 8-1

Income Tax Assessment Act 1997 - Section 110-35

Income Tax Assessment Act 1997 - Division 40

Income Tax Assessment Act 1997 - Section 110-35

Income Tax Assessment Act 1997 - Division 380

Income Tax Assessment Act 1997 - Section 380-35

Reasons for decision

Initial expenses

Section 8-1 of the Income Tax Assessment Act 1997 (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 incurred in producing exempt income or non-assessable non-exempt (NANE) income. 

Taxation Determination TD 95/60 considers whether fees paid for obtaining investment advice are an allowable deduction under section 8-1 of the ITAA 1997. Generally, initial advice or fees incurred drawing up an investment plan are not deductible under section 8-1 of the ITAA. This is because it is not expenditure incurred in the course of gaining or producing the assessable income from the investment(s). It is too early in time to be an expense that is part of the income producing process. It is an expense that is associated with putting the income earning investment(s) in place, and, therefore, has an insufficient connection with earning income from the investment(s) (paragraph 3).

In your case, you incurred an initial fee and an application fee and a valuation fee when the land settled. These expenses were incurred in relation to the acquisition of the property and, therefore, are considered to be a capital expense and specifically excluded as a deduction under section 8-1 of the ITAA 1997.

The expenses would be included, however, under the second element of the cost base for CGT purposes which includes the incidental costs incurred to acquire the CGT asset or that relate to a CGT event that happens in relation to the asset. These incidental costs include:

· professional fees including the remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser

· costs of transfer

· stamp duty and other similar duty

· costs of advertising or marketing (but not entertainment) for a buyer or seller

· valuation or apportionment costs

· search fees relating to a CGT asset (such as fees to check land titles and similar fees, but not travel costs to find an asset suitable to purchase)

· the cost of a conveyancing kit (or similar cost), and

· borrowing expenses (such as loan application fees and mortgage discharge fees).

Rental property expenses

As stated above, 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 incurred in producing exempt income or NANE income. 

Expenses incurred in respect of a rental property are generally considered to be incurred in gaining or producing assessable income and, subject to the operation of sub-section 8-1(2) of the ITAA 1997, are therefore deductible.

Apportionment of expenditure is necessary where it serves both an assessable income producing end and some other end: (Ronpibon Tin NL v FC of T (1949) 8 ATD 431).

While derivation of assessable income by way of rent is one objective achieved by participation in the NRAS, the receipt of government incentives, including state government NANE income is another.

Expenses are not deductible to the extent they are incurred in gaining NANE income (paragraph 8-1(2)(c) ITAA 1997). Accordingly, rental expenses incurred in respect of a rental property must be apportioned, limiting a claim for any deduction to the portion of costs relating to the derivation of assessable income.

Capital expenses

Division 40 of the ITAA 1997 allows a deduction for an amount equal to the decline in value of a depreciating asset you held during the income year. Subsection 40-25(2) of the ITAA 1997 provides that any deduction must be reduced by any part of the decline in value attributable to a purpose other than a taxable purpose.

Similarly, Division 43 of the ITAA 1997 allows a deduction for capital works in an income year where the area was used for the purpose of producing assessable income. Again, any deduction must be apportioned if the area was used to produce both assessable and exempt income.

In your case, you have incurred rental property expenses, including an annual administration fee (calculated at Y% of the available incentives) capital works and decline in value. As stated above, where the property is used to produce both rental income and government incentives, including NANE income, any deduction otherwise allowable will need to be apportioned to reflect this dual purpose using the following formula.

Apportioning expenses

Generally, the apportionment of expenses would be made using the following formula to calculate the percentage of deductible expenses:

Assessable rental income derived from the property / (assessable rental income + NANE income associated with the property) x otherwise deductible expenses

For example:

Where you have reduced rental income of $20,000, NANE of $3,000 and rental expenses of $10,000:

$20,000 / $23,000 x $10,000 = $8,695.65

The deductible portion of the expenses is $8,695.65

CGT

Some of the expenses incurred to produce the NANE portion of the rental income maybe able to be included in the asset's cost base for CGT purposes.

The third element of the cost base is made up of the 'costs of owning' a CGT asset

The costs of owning the CGT asset include:

· interest on money borrowed to acquire the asset

· costs of maintaining, repairing or insuring it

· rates or land tax, if the asset is land

· interest on money borrowed to refinance money that was borrowed to acquire the asset; and

· interest on money borrowed to finance the capital expenditure incurred to increase the asset's value.

Subsection 110-40(2) of the ITAA 1997 states that the third element dose not include expenditure that you have or can deduct.

Example - Rental Property

Robyn purchased a rental property in December 1993 using borrowed funds.

The property was let to a family member for rent at less than market value.

The property was sold to the family member in November 2005.

Robyn was aware of paragraphs 13 to 16 of Taxation Ruling IT 2167. She adopted the method of deducting rental expenses (such as interest paid on the borrowed funds), equal to the rental income received.

Therefore those expenses in excess of the rental income that are not allowable as a deduction, and relate to owning the CGT asset, would form part of the third element of the cost base.

These expenses would include:

· Interest on borrowed funds or refinancing borrowings, to acquire the property

· Interest on borrowed funds to finance any capital expenditure incurred to increase the asset's value

· Rates and land taxes

· Repairs and maintenance

· Insurance

As discussed above, a portion of the expenses you will incur in respect of the rental property, including insurance, repairs and loan interest, will not be deductible. Therefore, the remaining non-deductible portion of these expenses can be included in the third element of the cast base for CGT purposes.