Edited version of private advice

Authorisation Number: 1052163264691

Date of advice: 31 August 2023

Ruling

Subject: Rental property - deductibility of expenses

Question

Are the expenses incurred by the Taxpayer in respect of a residential property fully deductable against the rental income received?

Answer

No.

Having considered your circumstances and the relevant factors under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) and referring to Taxation Ruling IT 2167 Income tax: rental property - non-economical rental, holiday home, share of residence, et. Cases, family trust cases, you can only claim expenses related to renting out that part of the home.

You need to apportion the expenses for both private and income-producing use. Additionally, as the rental income is less than normal commercial rates, you can only claim deductions equal to the amount of rent received during this period.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You own your residential property (the property) as joint tenants.

The property is your main residence.

You have let one bedroom in your property to a university student, whom is also your friend.

The student is currently completing their PhD at University and was initially funded through a scholarship.

The bedroom is located in the downstairs area of your main residence. The student also has access to communal areas upstairs, such as the kitchen.

The student commenced renting the bedroom mid 20XX and was paying $XX per week.

You considered this amount fair and reasonable after researching the market value of comparable rent in the vicinity of the University.

In XX 20XX, the student advised that they no longer had scholarship funding.

You offered to reduce the rent as a goodwill gesture.

The rent was reduced to $XX per week and at this stage there is no intention of increasing the rent back to market value.

The room was not advertised for rent and there is no formal lease agreement in place.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

Detailed reasoning

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes all ordinary income derived directly or indirectly from all sources.

Ordinary income includes rental income earned as a result of renting out your property, or part of your property.

In your case, you have used your home to provide accommodation to a student. You have reduced the rent to an amount below market value. This payment covers accommodation (1 bedroom), with access to communal areas within the house. You have advised that the intention of providing the accommodation is to make a profit.

In FCT v Kowal (1983); 79 FLR 75; 15 ATR 125; 84 ATC 4001 (Kowal's case), the taxpayer was renting to a relative at below market rate. The Court found that the taxpayer had two objectives in mind. One was to provide his relative with a good home at moderate cost. The other was to earn assessable income. The Court determined that the rent was assessable income.

However, a different result was found in FCT v Groser (1982); 65 FLR 121; 13 ATR 445; 82 ATC 4478 (Groser's case). In this case, the taxpayer permitted his invalid brother to reside in a house he owned for a nominal rent of $2.00 per week. It was held that the nominal weekly rental payments received by the taxpayer from his brother did not constitute assessable income as the payments were a contribution to the costs of maintaining the home.

Paragraph 14 of IT 2167 Income Tax: rental properties - non-economic rental, holiday home, share of residence, etc. cases, family trust cases, states that unless the arrangements are comparable to those in Groser's case, rent received would represent assessable income.

In your case, we consider that there is a benefit being conferred to you, the owner of the property. Whilst the amounts you receive from the student do not reflect the market value for rent, we consider that you make a financial gain from the student's payments. Therefore, these amounts are assessable under section 6-5 of the ITAA 1997 and should be declared as income by you in your income tax return.

Non-arm's length arrangement

Taxation Ruling IT 2167 discusses arm's length and non-arm's length letting of a residence. Generally, the approach to be followed is based on whether the rent charged by the owner represents a normal commercial rent.

Paragraph 14 of IT 2167 also states that while less than commercial rent can represent assessable income, it would not necessarily follow that, losses and outgoings in relation to this are wholly deductible. The normal commercial practice would be that a property is rented primarily for profit.

The agreement between you and the student is a verbal agreement. The room has not been advertised to a broad population and therefore exposure is limited. A non-arm's length arrangement does not have the appearance of normal commercial distance between unrelated parties. The outcome of your arrangement is different to what they would be if the parties were not related or connected in some way.

In your case, as the rental income is less then market value, you can only claim deductions equal to the amount of rent received during this period. The decision to reduce the rent was a goodwill gesture and therefore there is a purpose other than income production.

Only part of a property used to earn rent

In cases where a taxpayer is residing in a dwelling and also using part of the dwelling to earn rent, only that portion of an allowable expense which relates to the rental income can be claimed as a deduction. As a general guide, apportionment should be made on a floor-area basis that is, by reference to the floor area of that part of the residence solely occupied by the tenant, together with a reasonable figure for tenant access to the general living areas, including garage and outdoor areas if applicable.