Edited version of private advice

Authorisation Number: 1051518536752

Date of advice: 17 May 2019

Ruling

Subject: Are you in business - rental properties

Question

Are you carrying on a business of letting residential rental properties?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own residential rental properties.

In the 20XX income year you sold one of the properties. With the proceeds from the sale of this property you are building another property on land at the back of another of your rental property.

You currently have X rental properties.

Some of the rental properties produced a net taxable income which indicates a profit making purpose. All of the properties combined produce taxable income.

You have provided details in relation to your properties as of the 20XX income year:

You manage the properties by:

·         liaising with the tenants

·         obtaining new tenants

·         lease negotiations

·         lease preparation

·         tenant evictions

·         either engaging a trade person to carry out repairs and maintenance or else doing it yourself.

You do not have another job apart from managing these properties. You spend an average of a small number of hours per week managing your rental properties.

You have retired from your full-time employment. You currently receive a pension.

In addition to the new rental property currently under construction, you intend building more rental properties in the future on land you own.

You negotiate twelve month leases, however, sometimes they are shorter but shorter leases are neither common nor usual.

You do not have a formal written business plan. But you have plans to develop your assets by building a new dwelling on land you own.

You do not engage a real estate agent.

You advertise in a newspaper and on Gumtree. You note that increasingly the later as it is more effective way to obtain tenants.

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 26-31

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Summary

You are not considered to be carrying on a business of letting rental properties and are considered a passive investor under Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Carry on a Business?

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

Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? provides the Commissioner's 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

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

These 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 from looking at all the indicators, and whether these factors provide the operations with a commercial flavour. The weighting to be given to each indicator may vary from case to case.

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

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. If rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

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.

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.

Application to your circumstances

In your situation, you are the sole owner of several properties. You advertise for tenants by advertising in a local newspaper and online via Gumtree. You manage the properties yourself by liaising with the tenants, obtaining new tenants, conducting the lease negotiations, preparing leases, handling tenant evictions. You also do the property maintenance where you can.

Your sole ownership of the properties is currently positively geared and this profit is generated from your rental income in the 20XX income year. However, the net proceeds from your activity are substantially lower than that of a business or commercial level.

Your properties are rented out to the respective tenants on 12 month leases; shorter leases are not common or usual. This is considered to be a reasonably long period. 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.

While the maintenance of the properties is generally undertaken by you where you can, the level of repetition of the activity is not as great as that noted in Case G10 which involved twelve units used for short-term accommodation. The activities of the taxpayer in that case was far greater than in your activities in relation to your properties, being a seven day a week activity and the size and scale of the activities undertaken by the taxpayers.

Your facts are similar to the facts contained in Example 3 of the Rental Property Guide in relation to the activities undertaken by the owners which are viewed as not being in business, with the exception of the number of properties involved in the example being three as opposed to your X properties.

Example 4 in the Rental Property Guide outlined a scenario of taxpayers who owned 26 properties and were viewed as carrying on a business. While you currently have X rental properties, your facts are dissimilar because:

·         The D'Souza's spent on average 25 hours per week on the activities related to the rental properties while you state you only spend around 8 hours per week;

·         The D'Souza's carry out regular inspections while you do not state that you carry out inspections; however, you do maintenance work where you can; and

·         The D'Souza's have no other sources of income apart from the rental income and income earned from shares. However, you receive a pension.

You keep records in relation to your properties. The types of records and tracking 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 properties.

You have X solely owned properties which is less than in Case 26 and Cripps' Case.

The level of repetition and regularity and the scale of your activities related to your rental property is not as great as that noted in Case G10 where the taxpayers rented out short term holiday units and not as great as 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. Your income is from the rental activity which is investment in nature, and you are not providing any additional income generating services.

You consider that you are in business due to the fact that you have rented X properties with plans to construct additional properties and you have derived a small net profit from this activity. The level of services provided by you as the owner, whether personally or otherwise in addition to merely letting the property is a significant factor in determining whether a business is being carried on.

The main services provided by you were some repairs and maintenance to the properties, and advertising and viewing of prospective tenant's applications. All administrative tenancy operations such as lease agreements, bond lodgement processes, and some maintenance on the property were looked after by you. In strict legal terms, a lease is a contract where one party (the landlord) conveys exclusive possession of some property to another party (the tenant) for a period in exchange for some form of consideration without there being any intention that the tenant will buy the property during or at the end of the period.

The consideration is payable to the landlord as owner of the property and not in respect of any other activity undertaken or provided by, or on behalf of the landlord. In such cases, the landlord would continue to have the obligation to pay ownership expenses in relation to the property and would generally be expected to incur expenses to maintain the property in a state consistent with the requirements of the lease contract.

Generally, lease contracts would be expected to run for longer periods of time. This contrasts with shorter term contracts where the tenant might only be provided with a right to occupy premises and not exclusive possession. It is significantly more common in shorter term cases that the consideration will then also contain components in respect of specific services provided by the owner such as meals or cleaning. 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.

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, where the tenants have exclusive possession and control access to and from the property. 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.

After weighing up the relative business indicators and objective facts surrounding this case and based on the information provided, it is the Commissioner's view that your rental property activities are better described as leasing residential properties to receive income from a stream of rental income. The income is not derived from the services you provide, but from the letting of the property.

In short, there is nothing special about the manner in which you conduct your rental activities that transform those activities from an investment into a business. Accordingly, it is the Commissioner's view that you are not carrying on a business of letting rental properties.