Edited version of your private ruling

Authorisation Number: 1012437954957

Ruling

Subject: Legal and property expenses

Question 1

Are you entitled to a deduction for the portion of legal expenses relating to seeking compensation for the period when no rental income was received?

Answer

No.

Question 2

Are you entitled to a deduction for the portion of legal expenses relating to reclaiming costs of strata, rates, water, electricity and interest expenses?

Answer

No.

Question 3

Are you entitled to a deduction for the cost of settlement and transfer of title?

Answer

No.

Question 4

Does the amount paid to the previous co-owner form part of your cost base for capital gains tax purposes?

Answer

Yes.

Question 5

Are you entitled to a deduction for legal expenses incurred in retrieving your belongings or returning your ex-partner's belongings?

Answer

No.

Question 6

Are you entitled to a deduction for 100% of expenses such as interest, rates, strata, water, and electricity before the date 100% ownership is showing on the title deed?

Answer

No.

Question 7

Are you entitled to a deduction for 100% of expenses such as interest, rates, strata, water, and electricity from the date 100% ownership is showing on the title deed?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 July 2011

Relevant facts

You purchased an investment property as tenants in common. You held a majority ownership in the property.

The property was rented. Rental income went into a joint bank account. The rental was organised through a real estate agent.

You declared your ownership percentage of the rental income as assessable income.

Later your relationship with the co-owner ended and court proceedings commenced.

The property was in dispute.

The other owner advised the property manager that no tenants were to be allowed into the property. They also refused to pay their share of the loan expenses and other property costs.

To avoid defaulting, you paid the entire interest payments.

No rental income had been received for several months.

Court proceedings occurred to have the property transferred into your name only.

It was agreed to pay the previous co-owner an amount in order to settle.

You paid the previous co-owner the agreed amount for settlement of property and transfer of title.

Your co-owner went on holidays and had not signed the bank transfer papers.

Settlement was finalised a few months later.

The certificate of title then specified that you were 100% owner.

The previously joint loan was then transferred into your name only.

You incurred legal fees to attempt to reclaim costs of strata, rates, water, electricity, interest and foregone rent over the relevant period.

You also incurred legal costs in relation to retrieving your belongings, returning belongings to your ex-partner and resolving settlement of another jointly owned non-income producing asset.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

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 relate to the earning of exempt income, or a provision of the ITAA 1997 prevents it.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478), 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

In determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. For example, where expenditure relates to an enduring benefit, the expenditure is of a capital nature and the expenses are not deductible.

However, legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

It should be noted that the character of legal expenses is not determined by the success or failure of the legal action.

In your case you incurred legal expenses in relation to seeking compensation for the loss of rent. However such expenses relate more directly to the fact that the property was not available for rent rather than an existing tenant not paying their rent. As the underlying cause for no rent being received lies with the dispute between the co-owners of the property, the associated legal expenses are not sufficiently related to the earning of your assessable income and are therefore not deductible.

Costs incurred for rates and water charges for an investment property which is being used to produce rental income are generally allowable deductions under section 8-1 of the ITAA 1997. However where you do not have 100% ownership in the property, you are only entitled to the relevant portion of these costs.

Taxation Ruling TR 93/32 Income tax: rental property - division of net income or losses between co-owners refers to the division of the net income or loss between joint owners of a rental property. TR 93/32 states that the income/loss from a rental property must be shared according to the legal interest of the owners except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title.

In your case, you owned a majority of the property. Your previous partner remained the legal owner of the remaining interest in the property until the transfer had been completed. It is acknowledged that court proceedings and money was paid before this date, however such events did not give you an equitable interest in the remaining interest of the property before this. Although you paid 100% of the expenses for a period, this does not give you a legal or beneficial interest in the co-owner's share of the property.

Therefore, as you are not the legal or equitable owner of the remaining portion of the property before the title deed was changed, you are not entitled to any deductions in relation to this portion of the property.

It follows that the associated legal expenses in recovering the unpaid share of the property expenses such as strata costs, rates, water electricity and interest are not deductible, as they do not sufficiently relate to your assessable income and do not relate to any allowable deductions.

Legal expenses incurred in splitting of joint assets and returning other goods to the correct owner do not relate to your income earning activities. That is, there is insufficient nexus to your assessable income. Also the expenses are private or domestic in nature.

Therefore, legal expenses incurred in retrieving your belongings and returning belongings to the other person and the settlement of a jointly owned non-income producing asset are not deductible under section 8-1 of the ITAA 1997.

Cost for settlement and transfer of title

The costs of purchasing a property or an interest in a property is capital in nature and therefore not an allowable deduction. You are not entitled to a deduction for the costs incurred.

However such costs form part of your cost base for capital gains purposes.

A property is regarded as a capital gains tax (CGT) asset and the CGT provisions apply on the future sale of your property. Any net capital gain is included in your assessable income.

A capital gain is made if the capital proceeds (amounts received from the CGT event) are more than the cost base (the total costs associated with that event). Cost base of a CGT asset includes the money paid in respect of acquiring the CGT asset as well as costs of transfer and stamp duty. Therefore the amount paid forms part of the cost base of your property.