Edited version of private advice

Authorisation Number: 1052214273464

Date of advice: 8 February 2024

Ruling

Subject: Travel deductions - rental properties

Question

Can you claim the cost of travel to your rental properties as a deduction under section 26-31 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2023

Year ending 30 June 2024

Year ending 30 June 2025

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You have been letting rental properties for several decades.

As at 30 June in the relevant year you held X rental properties, having sold one in the course of that year.

You have held up to XX properties in previous years but have sold a number of these properties to reduce the debt that is increasing with rising interest rates.

You each have half ownership of these properties.

You decided to invest your time and resources into this activity after searching for opportunities and settled on rental letting as it offered a purchase price to income ratio suitable to your circumstances, suited your abilities, and your future lifestyle aims.

You chose to invest in properties that are interstate because the price of properties closer to where you live would have meant taking on more debt than you were comfortable with.

You did extensive research on the market for rental properties, noting features such as proximity to employment possibilities, transportation, shopping facilities, and schools as well as planned development of the area.

You purchased properties that would be cash positive within a short time from their purchase.

You both have experience in and enjoy property renovation and maintenance and enjoy the physical activity.

You have subscribed to investment literature such as the Australian Property Investor magazine in the past and have more recently relied on multiple internet-based resources.

You subscribe to and attend seminars such as those provided by specialists in financial and accounting advice on property investment.

You have also read widely on both residential and commercial property investment and watched professional education videos on these topics.

You also consult the ATO website on a regular basis to keep up to date on the taxation implications and treatment of your investment properties.

You and your partner claim you are spending about 43 hours a week on this activity. One partner has full time work elsewhere.

Your plan for this activity is based on the purchase, renting, and maintenance of residential rental properties so you can pay off the debt you have undertaken to buy them while you are still working.

In the longer term you aim to build an income stream to support you in your retirement.

You may sell some of the properties as you transition to retirement to reduce the ongoing loan repayments.

The scope of this plan was widened when you took the opportunity to purchase a block of land in and build and furnish a set of units to add to your portfolio. This block was in a location that offered significant growth potential due to the existing and newly developing industries in that location. Most of your other property titles also permit future subdivision or development.

The market value you have supplied for your properties is based on estimates made by your bank. The total market value of your properties as 30 June in the relevant financial year was over $XXX, and the debt to value ratio for your portfolio is about 25%.

You undertake overall management of your properties but engage real estate agents to collect rents, maintain leases, advertise for and select suitable tenants, prepare lease documents and take and lodge bond moneys.

You have agreements with the real estate agents whereby you organise, coordinate, or undertake all maintenance and repairs of the properties yourselves as and when required.

By agreement with the real estate agents you carry out property inspections twice a year and they carry out inspections in between your visits.

The rental rates for your properties are aligned with market values.

You select real estate agents to manage your properties based on their personal, communication, and organisational skills, their flexibility and ability to source suitable tradespeople, and their fees.

You negotiate their fees with them and seek discounts for listing multiple properties with them.

You regularly assess the performance of real estate agents. If found to be inefficient or not proficient you will change agencies, and have in the past managed some of your properties without using real estate agents.

Where the property repairs are substantial you also attend to supervise tradespeople and assist as required.

Engaging real estate agents also reduces your landlord insurance costs.

You paid nearly half a dozen interstate visits to your properties in the relevant financial year, spending about a week on each visit to attend to regular management and maintenance issues, and other maintenance and repair tasks as the need arose.

Your expenses across all these properties included council rates, insurance, interest, property agent fees and commissions, repairs, maintenance, stationary, travel expenses, and water charges. You also paid significant amounts for the travel to and from your properties.

You had 2 changes of tenants in the relevant financial year.

Your expenses across all these properties included council rates, insurance, interest, property agent fees and commissions, repairs, maintenance, stationary, travel expenses, and water charges.

In the relevant financial year, you incurred significant travel and repair expenses for this activity.

You paid significant amounts for travel to and repairs at your properties in the relevant financial year.

Your projected gross rent for the relevant financial year exceeds your expenses.

You are expecting similar amounts of profit for the following financial years. You and your partner each receive an equal share in this income and claim equal shares of the expenses.

Your involvement in this activity includes financial monitoring and planning, making decisions associated with the letting process in regular meetings and documenting these decisions.

You maintain a banking structure that helps manage and schedule payments such as loans, interest, insurance, council fees, water charges, repairs.

The accounts are all held in your joint names.

You do not use single accounts for individual properties.

You maintain records of income and expenses for all properties using a spreadsheet and this allows you to maintain currency of your landlord insurance and monitor the financial position and performance of your properties.

You manage your activity from an office within your home.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 26-31

Reasons for decision

Claims for deductions of travel expenses incurred in gaining or producing assessable income from residential properties used for rental accommodation are allowed by section 26-31 of the ITAA 1997 if you are carrying on a business of letting rental properties. Travel expenses incurred in gaining or producing assessable income as an investor not carrying on a business cannot be claimed as a deduction. In determining whether you can claim the cost of your travel to your rental properties we must first determine whether you are carrying on a business of letting rental properties.

Whether the activity of letting property amounts to the carrying on of a business will depend on the circumstances of each case. 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 scale of the rental property portfolio and the nature and extent of the involvement of the owner in the provision of services to the tenants of these properties.

Taxation Ruling IT 2423 Withholding tax: whether rental income constitutes proceeds of business - permanent establishment - deduction for interest states at paragraph 5:

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

In Administrative Appeals Tribunal (AAT) case YPFD and FCT [2014] AATA 9 (YPFD), the following statement about the tests that are relevant when the issue involves residential rental properties was made:

16. The Tribunal suggested in Shields v Deputy Federal Commissioner of Taxation (1999) 41 ATR 1042 and, more recently, in Smith and Commissioner of Taxation (2010) 79 ATR 934, that relevant matters might include:

(a) the nature of the activities and whether they have the purpose of profit-making;

(b) the complexity and magnitude of the undertaking;

(c) an intention to engage in trade regularly, routinely or systematically;

(d) operating in a business-like manner and the degree of sophistication involved;

(e) whether any profit/loss is regarded as arising from a discernible pattern of trading;

(f) the volume of the taxpayer's operations and the amount of capital employed by him; (by 'her' in the present case).

In this case the applicant owned 9 rental properties managed through real estate agents but also spent time on a regular basis performing additional management activities and arranging maintenance. The tribunal noted that reliance on real estate agents did not preclude consideration of their being in business and, taking the volume of their operations into account decided in their favour.

In Allen v Federal Commissioner of Taxation [2021] AATA 2768 (Allen) it was held the applicant was carrying on the business of letting rental accommodation involving 9 properties worth $6,000,000. The applicant had the purpose of maximising net rent, and the volume of their operations and the capital invested were considered significant. With a net worth of $3,475,000 the portfolio debt to equity ratio was thought to be consistent with a net rent or profit motive. The activities undertaken by the applicant were significant in nature and included the personal involvement of the taxpayer in the planting and maintenance of gardens, cleaning, property maintenance and repairs, lease preparation, attendance to legal disputes, and extensive development of their existing holdings to accommodate more tenants. It was estimated that the development of their existing holdings would increase their annual rental income by $120,000. The tribunal decision considered the extent and nature of their activity as well as their prospects for profit, and found their activities were more than that of a passive investor.

The factors outlined in these court decisions are taken into consideration in the indicators set out in the Commissioner's view on whether a taxpayer is carrying on a business as set out in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? While written for primary producers, these indicators are the consolidation of many years of case law and have broad application over many industries. TR 97/11 identifies the following indicators for consideration in determining whether a taxpayer is carrying on a business for taxation purposes:

•         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 repetition and regularity of the activity

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

•         whether the activity is planned, organised, and carried on in a businesslike manner such that it is directed at 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 a sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

Whether the activity has a significant commercial purpose or character

An activity can be considered to have significant commercial purpose or character if it has a business plan, a profit-making purpose, and can be shown to be carried on in a commercially viable manner. The business planning process itself includes knowledge of or research into marketing the product or service provided, capital requirements and how these might be met, costs, legal requirements, and the size and scale needed for commercial viability.

You have been letting residential rental properties for several decades, have experience in and enjoy property renovation and maintenance, and enjoy the physical activity involved. You first bought into rental letting as an activity, and rental letting properties in Queensland in particular as it offered a purchase price to income ratio suitable to your circumstances, your abilities, and your lifestyle aims. When purchasing properties to rent you did extensive research on the market for rental properties, noting their proximity to employment possibilities and amenities, and also their potential for short term positive cash flows. Your plan for this activity is to let and maintain these properties so you can pay off the debt associated with their purchase before you retire from the workforce. The scale of your current holdings has been comparable with those in both the YPFD and Allen cases but is progressively decreasing as you sell properties to lessen the impact of rising interest rates.

While you have a plan for your investment activities, this does not amount to a business plan. A profit-making purpose alone would not indicate a significant commercial purpose or character, as a profit-making purpose is also a character of investment activities. The sale of properties in reaction to rising interest rates indicates a reduction in commercial viability.

Whether there is a purpose of profit as well as a prospect of profit from the activity

A business must have a purpose as well as a prospect of profit. This includes planning and activity that is directed towards making a profit and being able to demonstrate how that profit is to be made. In the Allen case the applicant was developing existing holdings to accommodate more tenants and increase his income, and making a significant profit.

Your overall aim with this activity is to build an income stream for your retirement years based on the rent you receive from letting these properties. You have in previous years subdivided your land and built on those subdivisions so you can increase your rental letting portfolio. You have in recent years also sold a number of properties so you can maintain your debt to income ratio at a comfortable level. In the relevant financial year you made a profit from your rental income, and you expect this to increase to more than double in the following 2 financial years.

As stated above, simply having a purpose and prospect of profit is not significant in distinguishing a business from an investment, in contrast with distinguishing a business from a hobby, as both investing and business share the goal of achieving a profit.

Whether there is repetition and regularity of the activity

Activity must be undertaken on a continuous and repetitive basis, as appropriate to the industry, for it to be considered a business. In the Allen case the applicant was occupied for the larger part of their working week with their extended involvement in the management, maintenance, and further development of 9 properties. Your rental letting activity is continuous and undertaken on a repeated basis, and you and your partner spend over 40 hours a week on this activity. Your regular activity includes financial monitoring and planning, managing the rental income and expenses, maintaining records, liaising, and negotiating, and coordinating with real estate agents and tradespeople on maintenance and repairs.

You undertake inspections of your properties twice a year, liaising directly with tenants, and coordinating with real estate agents and tradespeople in the course of visits to your properties. In the relevant financial year you made a number of interstate visits to your properties, each for about a week, and more than half of these were for renovation, maintenance, and repairs to those properties.

These activities, whilst repetitive and seemingly regular, do not amount to more than the activities that a savvy investor would complete in managing a rental property portfolio.

However, the majority of the rental activities of collecting rent, maintaining leases, advertisement for and selection of suitable tenants, preparation of lease documents and lodgement of bond monies, are handled by your real estate agents, not you.

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

An activity can more readily be recognised as commercial if it is of same kind and carried on in a similar manner to other businesses in the same industry.

You are taking a hands-on approach to the management of your properties, routinely and closely monitoring the performance of the real estate agents and tradespeople you employ to maintain these properties. You select, engage, and disengage these agents and tradespeople based on their performance and ability to meet your needs, and negotiate discounts for their services based on the number of properties you are listing with them.

Your properties are advertised for rent through real estate agents at market rates.

You choose to undertake all repair, renovation, and maintenance tasks on your properties personally on site, or through contractors of your choosing.

Your regular expenses include council rates, insurance, interest, agent fees and commissions, repairs and maintenance, stationary, and water charges. These are costs that would be faced by any property investor.

You have selected interstate property investments as these offered the best value at the time. You have to travel interstate to maintain these properties, and this, along with the close monitoring and hands on approach you have chosen means your travel costs are high. While the colocation of your properties across 2 cities allows some economy of scale for your activity this will be reduced if you sell further properties, and the cost of these choices may impact the ongoing viability of your operations.

Businesses in this industry generally have larger property portfolios and are more likely to outsource many of the current tasks you personally complete, to reduce the amount of travel expenses currently incurred and subsequently increase profits from the activity.

Whether the activity is planned, organised, and carried on in a businesslike manner such that it is directed at making a profit

An activity can more readily be characterised as a business when it is carried on in a planned, organised, and carried on in businesslike manner such that it is directed at making a profit.

Your rental letting activity is planned, organised, and carried on in a business-like manner. You regularly review the financial position and performance of your properties, and this allows you to plan your management of these properties. You document this review and planning activity, and maintain records of income and expenses for all of your properties using a spreadsheet. You use a diary system to schedule regular expense payments and ensure you meet your legal responsibilities. You manage your activity from an office within your home.

The size, scale, and permanency of the activity

An activity would be expected to be of a size, scale, and permanency suitable to the industry it is operating in to be recognised as a business. To be carrying on a business of letting rental properties there needs to be a significant size and scale of the rental property activities.

You have held 15 properties in the past and began the relevant financial year with a portfolio of 8 rental properties, one of which was sold shortly after that time. With 7 properties to let you now have a smaller portfolio than the 9 properties held in the YFPD and Allen cases. The market value of your properties at 30 June in the relevant financial year was close to half the $6,000,000 capital invested in the Allen case. You intend to live off the income generated from your properties in your retirement but may sell more to reduce the interest on outstanding loans. We do not consider 7 properties to be of the required size and scale to be carrying on a business of letting rental properties.

Summary

Your rental letting activity has a purpose and prospect of profit and is being conducted in a regular, systematic, and organised manner.

It has previously been of the size and scale of and carried on in a similar manner to other businesses in the industry, but is now being carried on at a volume and scale that is not considered to be commercially significant. You are not considered to be carrying on a business of letting rental properties, but rather investors.

Conclusion

As you are not carrying on a business of letting rental properties, you cannot claim the cost of travel to your rental properties as a deduction under section 26-31 of the ITAA 1997.