Edited version of your written advice

Authorisation Number: 1051435553684

Date of advice: 5 October 2018

Ruling

Subject: Carrying on a business – rental properties

Question:

Do your activities in relation to your rental properties during the 20XX-XX income year constitute a carrying on of a business?

Answer:

No.

This ruling applies for the following period

Income year ending 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

Background

You were awarded a diploma which you have used in relation to your properties and became a member of the relevant institute.

You registered for an Australian Business Number (ABN) as an individual/sole trader, with the trading name.

You purchased a number of properties prior to the 20XX-XX income year which were acquired for a number of reasons, such as:

● holding them as an investment property with a long term aim of being part of your future rental and development activities;

● in run down condition but located in a good suburb;

● to gradually do it up and then sell for a profit

● good price and could be easily rented with potential to hold for a few years before selling it for a profit;

● property located on large land area allowing for future potential, such a full subdivision or renovation; and

● potential for future development

You renovated and subsequently sold a property during a number of the following income years up to the 20XX-XX income year which involved getting council permits, finding local contractors, having discussions with local real estate agents to understand what buyers are seeking in the local area and gaining preliminary valuations before commencing the renovations.

A number of the properties were held for over nine years before being sold with a profit being made on their sale. Other properties were held for less than five year, with a loss being made on their sale.

Properties held during the 20XX-XX income year

You acquired various ownership interests in a number of properties as follows which you held during the 2017-18 income year:

Property sold during 20XX-XX income year:

Properties held during the 2017-18 income year:

Property purchased during the 20XX-XX income year

Property activities

You engaged the services of a real estate agent (the Agent) to manage the properties you owned during the 20XX-XX income year.

The Agent undertook the following letting and management activities:

● collecting rent;

● advertising the properties on their internet website;

● draw up the leases for your approval;

● provides 24/7 service for tenants;

● is the first point of contact for tenants if there is an issue with the property/ies;

● payment of invoices for repairs and maintenance charges;

● contacting you in relation to maintenance/repair issues;

● inspection of properties; and

● generally you pay a specified percentage of the rent collected to the Agent.

The properties leases are normally for either X to XX months duration.

The tenants are asked to contact the property manager as the first point of contact in relation to issues with the properties, who will contact you about maintenance issues. You will either undertake the work when possible, or engage the services of professional tradesmen.

You undertake all of the outside yard work, and most handyman work in addition to some plumbing. You do not do any electrical work. You have undertaken various activities in relation to fixing, replacing and improving your properties in the past such as painting, fixing showers, dripping taps, paving, fixing roof leaks, re-hanging doors, fixing locks, drawers, pruning and gardening, fixing damage to walls such as cracks and other plaster work, replacing blinds, curtains and fly screens, concreting, windows and flooring.

You schedule the work for every few months, unless the issue is dangerous or urgent, and address them when you are visiting the properties.

You have a shed located in each state that the properties are located in which you keep tools, ladders and materials used in relation to the maintenance of the properties.

You have a caravan that you tow behind your work ute and stay in local caravan parks while you are working on the interstate properties. While in the area you inspect other properties.

You estimate that you spend on average more than 20 hours per week on your properties as follows:

● office and management activities, less than 10 hours per week on average, which includes emailing, phone calls, payment of bills, researching trends and potential growth areas and property development, filing and record keeping, end of month reconciliation of rental payments, reviewing loan payments, reviewing upcoming bills, updating cash flow worksheets and budget projections and preparing end of year accounts and documentation and preparing income tax returns; and

● inspection and maintenance of properties, less than 7 hours per week for around 50 weeks; and

● renovations and improvement work in preparation to the sale of the property, estimated at less than 10 hours per week for around 50 weeks.

You normally spend a number of days during the months leading up to the renovations which can include a combination of your labour and you obtaining and managing contractors on site, with average hours per renovation estimated to be less than 200 hours.

You normally spend a week cleaning and touching up the paint work after the tenants move out.

You engage a real estate agent to sell the properties, with you being on call, estimated time involved being less than 100 hours.

During the 2017-18 income year you travelled to the interstate properties on a number of occasions to:

● undertake repairs, such as termite damage, pool fencing, fencing

● undertake maintenance work after taking possession of a new property in preparation to renting it out;

● attending ‘open house’ for new property and held discussions with the Agent about potential tenants;

● undertake renovation, repair and replacement work on property you were selling to in preparation for putting it on the market; and

● undertake house inspections on properties while you were in the area

In addition, you organised for tradesmen to address issues at the properties, inspected potential properties, dealt with solicitors in relation to the sale of a property and visited your bank in relation to refinancing issues.

You had dealings with a number of real estate agents with whom you are in contact with regularly, and from whom you receive newsletters and updates on market trends, some of which you have had dealings with for many years.

You keep a separate bank account that you use for your property activities.

You keep a filing cabinet in your home office and have a separate filing drawer for each of your properties in which you keep relevant documentation such as invoices, receipts and important documentation. You keep the files for each property for at least five years after the property has been sold.

You keep separate folders on your computer in relation to each property in which you keep emails relevant to that particular property.

You have registered and run your own domain and have a separate email address to keep your personal and/or family emails separate.

You pay for all of the council rates in relation to the properties. The liability for water rates varies from property to property with some tenants paying an excess amount per quarter, with other tenants being in the ‘water complaint properties’ where they pay the water rates.

You pay the electricity for some of the properties, with the tenant/s paying for their own electricity, depending on what has been agreed upon when the lease agreement was negotiated.

On average you worked less than 60 hours per month, or less than 10 days per month as an employee. During the 20XX-XX income year you earned $XX,XXX as an employee.

Property strategies

Your business strategy originally consisted of doing everything yourself, buying at the lowest price and then improving the property. You changed your strategy following the losses you made in relation to the sale of a number of properties prior to the 20XX-XX income year.

Your current business strategy consists of acquiring, improving and harvesting the properties using the following three phases which have a cycle time of X to XX years:

● Hurt - the initial pain period. No initial reward for a significant period of time with effort often needed to research, acquire and establish the property. It normally takes several years of inflation (rent) before the initial negative cash flow becomes neutral;

● Hold - a property should have neutral cash flow within a number of years and become increasing cash flow positive over a further number of years. Due to the State land tax rates, and to help spread the risk, you have considered having properties in more than one state; and

● Harvest – residential property has a history of doubling in capital value every X to XX years. The main reward in residential property investment comes from the increase in capital value, and not only from the rent income as net yields are often low. Your strategy is to harvest the increased capital value at some stage.

The actual timing depends on the property market cycles and the current conditions in each location. A property will normally have some renovation or development work before it is harvested to maximise its profit.

You normally have one property at the Hurt phase, potentially several properties in the Hold phase and one property in the Harvest phase.

Future properties

You anticipate expanding your property portfolio as you are currently holding significant cash and equity to allow that to occur. However, the property prices in a number of capital cities are currently too high to obtain a positive cash flow return.

You anticipate that there will be a drop in property prices and an increase in the average rents due to the extremely low yields at present. When the market changes you propose to buy in a capital city. You are still looking at potential properties to purchase in City A.

Rental amounts

You estimate that you received gross rent of $XX,XXX in the 20XX-XX income year, which included estimated rental income from Property D of $XX,XXX.

In previous income years you have recorded:

● capital gain amounts on the sale of properties in a number of income years; and

● net rental amounts for the properties ranging from losses for a number of years in relation to some of the properties, and small amounts of gains in the other income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 70-10

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Summary

You are not carrying on a business of letting rental properties. It is considered that the scale of activity and volume of operations carried on by you is insufficient to be considered as carrying on a business.

Detailed reasoning

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income includes income according to ordinary concepts. This ‘ordinary income’ includes amongst other things, income from salary and wages and business operations.

Section 8-1 of the ITAA 1997 allows you to claim a deduction for a loss or outgoing that is incurred in gaining or producing your assessable income, or necessarily incurred in carrying on a business to gain or produce assessable income. These deductions are limited by the exclusion of losses or outgoings that are capital, private or domestic in nature.

Carrying on a business

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

Normally the receipt of income from the letting of property to a tenant(s) does not amount to the carrying on of a business.

Whether the letting of property amounts to the carrying on of a business will depend on the circumstances of each case. Generally, it is easier for a company that derives income from the letting of property to show that it carries on a business than it is for an individual.

A person who simply owns an investment property or several investment properties, either alone or with other co-owners, is usually regarded as an investor who is not carrying on a rental property business. This is because of the limited scope of the rental property activities and the limited degree to which an owner actively participates in rental property activities. A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations.

The issue of whether individuals are carrying on a business of letting property has been considered in a number of cases, some of which are discussed below.

In Cripps v. FC of T 99 ATC 2428; (1999) 43 ATR 1202 (Cripps case), the taxpayer and his wife purchased, as joint tenants, 14 townhouses which they rented out. They also purchased a property which was used initially as a holiday home but was later periodically rented out. A further property was purchased for residential purposes. After a failed attempt to sell it, it was also rented out. The Administrative Appeals Tribunal found that the taxpayer and his wife were mere passive investors and were not in the business of deriving income from rental properties. They rejected the taxpayer's argument that he had greater involvement with his 16 properties. The Tribunal also made the following observation about Taxation Ruling IT 2423:

The Applicant asked me to note in particular paragraph 5 of Taxation Ruling IT 2423 (a non-binding ruling) which is referred to in clause 17 of TR 93/32 to the effect that: ``... if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business''.

Paragraph 5 of IT 2423 suggests only that a number of properties may indicate the presence of a business; it follows of course that it will not of itself be determinative.

In 11 CTBR (OS) Case 24 (Case 24), the taxpayer's income included rents from three properties. The taxpayer employed a manager and an accountant - he was principally a letting clerk with authority to refuse tenants. He collected and banked rents, attended to repairs and supervised them, and controlled the caretaker and cleaners. He kept books in connection with rents and repairs, and rates and other outgoings. The taxpayer said he personally carried out the principal part of the management of his rent-producing properties and directed policy, attended to the financial arrangements and made decisions regarding repairs. The taxpayer claimed that he was carrying on a business. In holding that he was not carrying on a business, a majority of the members of the Board of Review said:

It is obvious that some measure of supervision and management must ordinarily be exercised by a property owner who lets offices, &c., and if that does not amount to the carrying on of a business, the fact that he employs others to assist him, either in the letting of the properties or in the preparation of the accounts relating to his rents and outgoings, will not make any difference. For the foregoing reasons we are unable to uphold the claim that the taxpayer is engaged in a 'business as property owner’....

In 15 CTBR (OS) Case 26, (Case 26) the taxpayer derived income substantially from her joint ownership of a block of flats (containing 22 living units) with her sister-in-law. A swimming pool was shared with a neighbouring block of flats owned by the taxpayer's husband and his brother. A garden was maintained and a staff of one caretaker and one cleaner employed on both buildings with casual labour as required. The building was erected and financed by F & Co., the husbands of the joint owners, in the course of their business as building contractors. The general supervision of letting, rent collecting, servicing and maintenance was carried out by the owners or by F & Co. on their behalf. No charge was made by F & Co. for the extensive assistance given in the supervision of the flats. It was held that a business was not being carried on by the owners of the block of flats.

On the other hand, Case G10 75 ATC 33 (Case G10), the taxpayer owned two properties of which six units were let as holiday flats for short term rental. The taxpayer, with assistance from his wife, managed and maintained the flats. Services included providing furniture, blankets, crockery, cutlery, pots and pans, hiring linen and laundering of blankets and bedspreads. The taxpayer also showed visiting inquirers over the premises, attended to the cleaning of the flats on a daily basis, mowing and trimming of lawns, and various other repairs and maintenance. The taxpayer’s task in managing the flats was a seven day a week activity. The Board of Review held that the activity constituted the carrying on of a business. In reaching that conclusion, the Board found:

It was clearly established in evidence that the money received by the taxpayer from the occupants of the flats was not solely a payment for the right to rent a flat for a certain period.

Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? (TR 97/11) provides the Commissioners view of the factors used to determine if a taxpayer is in business for tax purposes. Its principles are not restricted to questions of whether a primary production business is being carried on.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

● whether the activity has a significant commercial purpose or character

● whether the taxpayer has more than just an intention to engage in business

● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

● whether there is regularity and repetition of the activity

● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

● the size, scale and permanency of the activity, and

● whether the activity is better described as a hobby, a form of recreation or sporting activity.

TR 97/11 states the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' ( Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

In the Rental Properties 2018 guide (Rental Properties guide) published by the Australian Taxation Office, it states the following at page 6:

Most rental activities are a form of investment and do not amount to carrying on a business.

The Commissioner sets out two examples in the Rental Properties guide that discuss the issue of whether or not the owner of one or more rental properties can be said to be carrying on a business.

Example 3 on page 6 of the guide, outlines a situation in which the owners are not carrying on a rental property business. The Commissioner states:

The Tobin’s owned, as joint tenants, two units and a house from which they derive rental income. The Tobin’s occasionally inspected the properties and also interview prospective tenants. Mr Tobin performs most repairs and maintenance on the properties himself, although he generally relies on the tenants to let him know what is required. The Tobin’s do any cleaning or maintenance that is required when tenants move out. Arrangements have been made with the tenants for the weekly rent to be paid into an account at their local bank. Although the Tobin’s devote some of their time to rental income activities, their main sources of income are their respective full-time jobs.

The Tobin’s are not partners carrying on a rental property business - they are only co-owners of several rental properties.

Example 4 on page 6 of the Rental Properties guide, outlines a situation in which the owners are carrying on a rental property business. The Commissioner states:

The D’Souza’s own a number of rental properties, either as joint tenants or tenants in common. They own eight houses and three apartment blocks - each block comprising six residential units - a total of 26 properties.

The D’Souza’s actively manage all of the properties. They devote a significant amount of time - an average of 25 hours per week - to these activities. They undertake all financial planning and decision making in relation to the properties. They interview all prospective tenants and conduct all of the rent collection. They carry out regular property inspections and attend to all of the everyday maintenance and repairs themselves or organise for them to be done on their behalf. Apart from income Mr D’Souza earns from shares, they have no other sources of income.

The D’Souza’s are carrying on a rental property business. This is demonstrated by:

● the significant size and scale of the rental property activities;

● the number of hours the D’Souza’s spend on the activities;

● the D’Souza’s extensive personal involvement in the activities; and

● the business-like manner in which the activities are planned, organised and carried on.

As shown in the above cases and the views of the Commissioner listed above, the indicators with the greatest weighting are the scale or volume of operations and the repetition and regularity of the activities.

Applying the relevant cases and indicators to your circumstances

In many instances, it is obvious that an activity is being carried on as a business and no further investigation is required.

Where it is less obvious, regard must be had for any other potential outcome when determining whether a particular activity should be considered to constitute a business and in determining the tests are to be applied in reaching such a determination.

There are many decided cases that consider the issue where the potential outcome is between ‘business or hobby’ or ‘employee or independent contractor’ (with an independent contractor being considered to carry on a business). In this case, we are considering the question of ‘Are you carrying on a business’ with the other potential outcome being that the activity constitutes an investment that generates assessable income.

We have made the following observations when determining whether your activities are the carrying on of a business:

● The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

The properties are leased out for lengthy periods of time. The payments you receive relate solely to the use of the properties by the tenants and do not relate to any services that you provide to them.

● The carrying on of a business is not merely a matter of intention alone. Rather, it is a matter of activity motivated by intention. It is appropriate to look objectively at the activity (including when it started) to reach conclusions about a taxpayer’s state of mind in deciding to conduct the activity.

Both business and investment will have a profit making intention whereas a hobby will not. Strategies that minimise the costs of pursuing a hobby will not amount to having a profit making intention.

In general terms, a business activity will be seeking to more efficiently allocate resources than a mere investment and will seek to conduct the activity in a way that provides a return that is higher than the investment levels received by others conducting similar activities. A business may seek to adapt to changing circumstances by altering the form or nature of the allocation of those resources. A business may be seen as being more open to taking risks to pursue these outcomes.

Properties A, B and C have been used in the current manner for an extended period of time, being for earning rental income.

You purchased Property D and undertook some repair and maintenance work/capital improvements to get it into a tenantable condition.

You are responsible for keeping the properties in a fit state of repair, but do not provide any direct services to the tenants.

● The taxpayer's involvement in the business activity should be motivated by wanting to make a tax profit and the taxpayer's activities should be conducted in a way that facilitates this. This will require examining whether objectively there is a real prospect of making such a profit from participating in the business of the taxpayer.

In relation to the properties held during the 20XX-XX income year:

● Property A and B were negatively geared during number of years prior to the 20XX-XX income year. The net profits made on those properties in other income years ranged from $XXX to $XX,XXX;

● Property C made a gain in a number of income years prior to the 20XX - XX income year ranging from $X,XXX to $XX,XXX;

● the net rental amounts made in relation to the properties during earlier income years were indicative of investment level rental amounts which is indicative of taking a longer term view and seeking a lower overall profit that is more reflective of an investment; and

● a gross capital gain of $XXX,XXX was made on the sale of Property A after you had owned it for more than XX years. The lengthy period you hold your properties may indicate that you are keeping your investment properties as long term investments similar to rental property investors.

You still have the following mortgages over a number of your properties:

● a loan obtained to purchase Property C which has not been reduced at this point and is more than the 80% Loan to Value Ration (LVR) of that property that you state you are seeking in relation to your properties; and

● a loan was obtained to purchase Property B which has been reduced by more than 40% since it has been held.

You state that you earned a total gross rental income of $XX,XXX during the 20XX-XX income year in relation to the properties you held ownership interests during the 20XX-XX income year, which includes an estimated $XX,XXX in relation to Property D. Based on the information provided we are unable to determine whether a gain or loss has been made in relation to each property during the 20XX-XX income year.

● The taxpayer's activities should involve repetition and regularity and have an air of permanence about them. With regards to letting of properties, repetition and regularity may be measured by factors such as regularity of maintenance, collecting of rent, management and advertising of the properties, insurance, dealing with tenancy agreements and inspection reports.

In comparison to some rental property owners your daily involvement is minor. Given the activities of other property owners who are considered to be carrying on a business of letting properties it could not be concluded the level of repetition and regularity of your activity is the same.

We are looking at those activities that would be required in the renting of properties. If there was a block of 30 holiday units rented on a short time basis there is an extensive amount of work conducted on a daily basis in meeting tenants, providing cleaning, linen and other services. The fees paid by the tenants are for both the services and the use of the property and if it is of sufficient scale, because of the regularity of these services it can be argued that they could be carrying on a business of renting properties.

Your property activities are of a different nature to this. Your lease periods are of a longer time frame.

The daily management of the properties is under the management of the Agent. Whilst you have advised that you inspect the properties, personally undertake the repairs, renovations, maintenance or organise for tradesmen to complete the repairs on the rental properties, and maintained accounts in relation to your rental properties, the activities you undertake in relation to your properties would also be undertaken by a property investor as was found in Case 24.

The level of repetition and regularity of your activities is not as great as that noted in Case 26 where despite the management and maintenance activities undertaken, the property owners were not considered to be carrying on a business of letting properties.

● If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v. Livingston 11 TC 538).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists.

During the 20XX-XX income year you had a property/properties in each of the ‘Hurt’, ‘Hold’ or ‘Harvest’ phase. Property owners who are carrying on a business in relation to their properties would be seeking positive returns from their properties and not hold them for lengthy periods to receive only negative or neutral returns as outlined in your business strategy.

Generally, where the property owners grant exclusive possession of the property to the residents the relationship between the two parties is one of tenant and landlord, and the activity is more likely to be passive investment rather than a business. Similarly, activities constituting the mere maintenance of an asset and the mere collection of income do not indicate the existence of a business of renting premises.

Your activity is renting out residential properties at market rates. This is similar to many other rental property owners who hold their properties as investments. Hence the relationship in respect of this test is indicative of a landlord and tenant.

Property owners carrying on a business in relation to property would include the property as trading stock of the business. Trading stock includes anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business. Where such a business exists, the proceeds from the sale will be accounted for on revenue account.

You sold Property A during the 20XX-XX income year. The spreadsheet provided indicates that an estimated total capital gain of $XXX,XXX was made on the sale of this property. In previous income years you have recorded the profits made on the sale of various properties as capital gains rather than as on revenue account as income of a business.

● The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities.

However, it is also reasonable to expect anyone investing in rental properties, including passive investors, to keep records in relation to their rental property/ies so that they can keep informed as to whether or not they are making a profit in relation to the rental property/ies and to make decisions as to what activities to undertake in relation to their rental properties to maximise their returns.

You keep a separate filing drawer for each of your properties in which you keep relevant documentation such as invoices, receipts and important documentation. Additionally, you keep separate folders on your computer in relation to each property in which you keep emails relevant to that particular property.

It may be arguable that rental property businesses might keep more detailed records than mere investments so that they can be better positioned to take advantage of opportunities that arise.

This test is more relevant when the potential alternate outcome is that the activity constitutes a hobby. Your activity does not have the nature of a hobby.

You engaged the services of the Agent to manage the properties, who provided tax invoices in relation to the properties, which is not dissimilar in the case of a property investor.

● When considering the size and scale of the activity we are looking at the scale in terms of the number of properties and what management input that may be required to conduct the activity.

Where size and scale is a relevant factor, the activity should be large enough to make it commercially viable as a business. In Cripps’ Case, it was held that the renting of 14 two storey townhouses was not a business and in McDonald‘s Case it was held that the letting of two units in different strata plans was also not a business. Similarly in Cases 24 and 26 the renting of 22 units and three properties respectively was also not considered a business.

You have rented out your rental properties for various periods during the 20XX-XX income year. The scale of your activities and volume of operations can be distinguished from the cases noted above given the small number of your properties.

Conclusion

After weighing up the relative business indicators and objective facts surrounding this case it is considered the information and documentation provided does not support that a business is being carried on in relation to your rental properties during the 20XX-XX income year.

Your rental property activities are better described as leasing residential properties to receive income from a stream of rental income in addition to holding the properties for significant periods to obtain the capital growth made on the properties during your lengthy ownership periods, plus incremental gains made to works undertaken on the properties prior to their sale.

The rental income is not derived from the services you provide directly to the tenants but from the letting of the properties.

Your properties are rented out for long periods to long-term stable tenants. There is no evidence to suggest that the properties are rented as short term (nightly or weekly) rentals; rather, they are rented under lease agreements which are typically long term in nature. The relationship between you and the occupiers of the properties is that of a landlord and tenant; where the tenants have exclusive possession and control access to and from the properties.

During the 20XX-XX income year you held a number of properties, selling one, buying one, and holding two properties purchased in previous income years. As outlined in Case 26 above, despite the scale of operations of 22 units, the AAT found a business was not being carried on by the owners of the block of flats. The quantity of rental units in that case is far in excess of your properties. Additionally, your circumstances are not similar to the examples provided in the Rental Property guide as outlined above.

The overall management of your rental properties is not dissimilar to other rental properties managed by an agent for a passive investor with the activities undertaken by the property manager in your case being of a similar nature to those undertaken in relation to properties owned by passive investors.

The types of records for a rental investment would be similar for both a passive investor and someone carrying on a business of letting rental properties given that rental income and expenses need to be recorded and property analysis reports and financial rations would be useful to invest further, or make any decisions about the performance of the rental property/ies.

Your business strategy consists of ‘Hurt’, ‘Hold’ and ‘Harvest’ phases. You described the ‘Hurt’ phase as a period of no initial reward for a significant period of time, and that it normally takes several years before the negative cash flow becomes neutral. Additionally, when in the ‘Hold’ phase, the property should have neutral cash flow within a further number of years, becoming increasing cash flow positive over a number of years. Your business strategy is more indicative of an investment strategy and not a business strategy. Businesses will be seeking a business or commercial return from their properties and it is reasonable to expect that anyone carrying on a business, or owning investment properties, to be seeking a positive return from owning the property and not to be holding properties that are negatively geared.

It is a rare business that does not seek to maximise its revenue by maintaining its assets to an acceptable standard, and while not decisive, it is relevant. But in doing that, it does not mean that they have conducted their activities in owning and managing the properties in a manner that is business-like. It would also be reasonable for an investor to renovate their rental properties to earn higher rental income and/or appeal to a different tenant market. This may involve seeking advice from real estate agents as to what activities could be done to the property to increase its rental appeal and potential rental returns.

You undertook activities on your properties on a number of occasions during the 20XX-XX income year. The additional activities you undertake for the rental properties such as carrying out repairs, maintenance, organising tradesman and/or renovations are not day-to-day activities. Additionally, those activities are in relation to keeping the properties in a condition suitable for them to be tenanted, not in relation to services to the tenants.

Activities were undertaken on Property D after it was purchased to get it in a condition to be fit to be tenanted out. These activities are viewed as being capital improvements to the property. It is reasonable to expect that anyone purchasing a rental property, whether as an investment or as business trading stock, would undertake activities to increase the amount of rental income that the property would earn, or to increase its appeal to a better class of tenant.

You seek advice from real estate agents on what activities should be undertaken in relation to the properties on how to obtain a higher sale price when selling your properties, and undertake renovations and other activities to get the property into a condition suitable for sale. It would be reasonable that any prudent investor, or a general homeowner, would undertake those activities in order to gain the maximum sale proceeds from the sale of their property. The main profit you make on the sale of your properties is made because you have held them for lengthy periods, such as being owned for more than 10 years in the case of Property A. The profit from the additional activities you undertake are incidental to the gains made from holding the properties.

It would be reasonable to expect any property owner, either in general or a passive investor, to undertake any similar repairs/maintenance/renovations they have the capacity to undertake so that they do not have to engage the services of tradesmen in an endeavour to cut down costs. The undertaking of those activities by themselves does not change the character of your rental property activities from investment to business.

The rental returns you received in relation to the properties are merely from holding the properties. The net rental amount recorded during the recent income years has either been relatively low profits or low losses. It is viewed that the taxpayer’s involvement in the activity should be motivated by wanting to make a profit and their activities should be conducted in a way that facilitates this.

It is stated that Property C is currently rented out at above the median rent for the suburb based on information sourced from a website in the state in which the properties are located which provides median rental amounts for two periods each income year for a four bedroom, two car space house. Property C is a five bedroom house with two car spaces and it is therefore expected that the rental income received for that property is higher than the median rental amount as provided on the website.

Additionally, the average amounts of gross rent you reported in relation to Property A, B and C in the 2016-17 income year were not as high as the median amounts provided at that website for four bedroom houses with two carports.

It is outlined in the spreadsheet provided that you received gross rent of $XX,XXX in the 20XX-XX income year.

Based on the rental amounts recorded it is viewed that you have been earning moderate gross rental in relation to a number of your properties in previous income years which is of an investment level. Based on the information provided we are not able to determine whether you have made a loss or gain in relation to your properties during the 20XX-XX income year.

You undertook employment activities during the 20XX-XX income year but state that your main source of income was your property activities with a significant amount of capital gains having been declared over the past income years. The capital gains, or profits, made on the sale of the properties were made due to the length of time that you held the properties, in addition to incremental profits made as a result of your activities to prepare the properties for sale. It is not unreasonable to expect that property investors may sell their property/ies if their market value increased so that they could realise the profit arising from holding their property/ies.

Accordingly, it is the Commissioner’s view that you were not carrying on a business of letting rental properties in the 20XX-XX income year and were a passive investor with a number of rental properties.

Note: As you are not carrying on a business in relation to your rental properties you cannot claim any travel expenses incurred in relation to your rental properties.

Any building materials purchased in relation to the properties will be included in the relevant property’s cost base.

A deduction can be claimed for tools and other items acquired in relation to earning your rental income. However, a deduction cannot be claimed for tools and other items used in relation to other activities, such as renovations, as they relate to capital improvements on the relevant property.