These 6 subjective questions will help you (and the ATO) see the bigger picture.
If you’re in the business of property, you can claim a range of work-related deduction that are no longer available to regular property investors. The ATO has some grey areas when it comes to deciding whether someone is a property investor, or operating a rental property business.
As such, this matter is decided on a case by case basis, and this article shouldn’t be used to make a final decision about your own situation. The purpose here is to provide you with the correct tools and knowledge to determine whether or not you might be missing out on eligible deductions.
The business of property development will not be covered here though, this is just about being in the business of residential rental properties.
Work-related deductions for property business include:
- Mentoring or attendance at property seminars and educational courses (these courses must teach systematic investing and trading techniques.)
- Other self-eduction expenses relating to rental property business
- Travel, such as motor vehicle expenses (the ‘cents per kilometre’ method is preferred to a log book percentage method.)
- Other work related expenses, such mobile phone, computer and stationery expenses (subject to substantiation.)
- Equipment purchases
- Deductions related to research for future rental properties
- Interest expenses
- Borrowings expenses
- Building depreciation
If the ATO considers you a Property Investor, and therefore not operating a rental property business, they will now allow you to claim any work-related tax deductions. As with any tax deduction you claim, documentation is a must.
Imagine you co-own three residential rental properties that you and your partner manage by yourselves. In this scenario, you both have full-time jobs, but also have some extra income from your rental properties.
According to the ATO, you and your partner are almost certainly Property Investors. In this case, you must share the rental income and property losses equally.
Rental Property Business Partners
Imagine you co-own 32 residential rental properties that you and your partner manage by yourselves. As there are so many properties and tenants, this task takes up a considerable amount of your time. Fortunately, you derive most of your total income from these rental properties.
In the eyes of the ATO, it’s very likely that you are carrying on a rental property business.
If this turns out to be the case, you and your partner have the ability to share your rental income and property losses in different proportions to your legal interests in the property. This must be done through a Partnership Agreement, and isn’t an option available to Property Investors.
GST and CGT
When you transition from being a Property Investor to carrying on a rental property business, your GST status does not change. This is because letting residential rental properties is input-taxed for GST purposes.
Capital Gains Tax concessions for small business will not necessarily apply to a rental property business. This is because residential properties are not wholly and exclusively used by the lessee in carrying on a business, and therefore not considered active assets.
It’s not that black and white though…
If you have less than three rental properties, it’s fairly unlikely that the scale of your operations would constitute carrying on a property business. However, this might not necessarily be the case after your operations are considered from a holistic viewpoint.
There are 6 indicators of a rental property business that allow the ATO to see the bigger picture, while providing you with some clarity on your tax payer status. However, it’s important to keep in mind that these indicators are subjective, and any decision about your status will be made from a holistic point of view.
The 6 Indicators of a Rental Property Business
Below are the 6 Indicators of a Rental Property Business; no one indicator is stronger than any of the others, and there is no determining number of the six that would definitively suggest that you’re operating a property business. We did say there were some grey areas!
1.Do my activities have a profit-making purpose?
Even if your properties are currently making a loss, you can still prove that the intent of your activities is to make a profit. Do you have a written Partnership Agreement that specifically states that the partner contributing more capital is to receive more income (or loss) based on their workload? This can support your claim that you’re operating with the purpose of profit-making, which will contribute to the argument that you are carrying on a business of letting residential rental properties.
In the case of substantial Negative Gearing, it may be quite difficult to argue that you are carrying on a business of letting residential rental properties. For example, claiming tax losses in 10 of the last 14 years does not indicate a profit-making purpose, and it’s likely that you will be deemed a Property Investor for tax purposes. However, the following 5 questions, holistically considered, may still indicate that you are, in fact, operating within a business-like structure.
2. What is the complexity and magnitude of my property activities?
Do you earn some rental income from an apartment or two? Or is your income derived from entire block of apartments? Would you say managing your properties is a complex, full-time job? The sheer size of your undertaking alone may indicate the existence of a business. Interestingly, hiring a rental property manager to do the job for you does not rule out the possibility that you’re running a property business. In fact, this could be a potential work-related expense to claim.
It’s important to distinguish between undertaking minor repairs and maintenance to avoid external contractors, and running a complex property business. In the eyes of the ATO, completing minor maintenance tasks does not constitute a business-like operation.
3. Do I engage in trade regularly, routinely or systematically?
How often are you purchasing new properties or re-financing your loan agreements?
If this isn’t a major part of your operations, it may be difficult to convince the ATO that you’re running a rental property business. If you think getting all your financial information together, such as rents received, accounting costs and agent fees might enough to be considered a business operation; think again. This is something Property Investors should be doing anyway!
Nonetheless, it’s still not entirely inconceivable that you might be operating a property business; there are still 3 more questions to be taken into subjective and holistic consideration.
4. Am I operating in a business-like manner, with a high degree of sophistication?
Do you outsource work that is beyond your area of expertise? For example, do you regularly employ Purchasing Agents to help you find additional properties to purchase? Are Investment Property Specialists taking care of your tax? If not, ABA can help!
Do you have a Common Law Partnership Agreement in writing, stating the amount of work to be completed by each partner, along with the appropriate compensation involved?
Do you have a Business Plan in writing, showing how your profit will be made through the process of owning and re-investing properties, as well as through mortgage reductions? For bonus points, your Business Plan will include a contingency plan to account for unforeseen circumstances.
Although having a detailed Business Plan will certainly help your case, it’s not a decisive factor on its own, as it’s not uncommon for Property Investors to have a business plan as well. Find out why.
5. Does my profit or loss arise from a discernible pattern of trading?
Are you actively involved in managing the properties, advertising for new tenants, and collecting rent, in addition to everyday maintenance? These activities point to a discernible pattern of trading, and can contribute to the argument that you are carrying on a business of letting residential rental properties.
Again, everyday property maintenance is not a sole deciding factor, and the ATO may still consider you a Property Investor after holistic consideration of your situation.
6. How does the volume of this operation, as well as the capital employed, compared to other rental property business operations?
Operating a rental property business requires a substantial amount of capital, but it can also return a sizeable income. How does the amount of capital used in your property activities compare to your overall wealth? If your rental income is significant, and especially if it’s your sole income, it can help convince the ATO that you’re carrying on a business of letting residential rental properties.
If your property operations are small in comparison to some of your other assets, such your share portfolio, this may indicate that your rental properties are passively held and not part of a business operation.
Do you think you might be eligible for work-related tax deductions?
Although there is a lot of grey area around this topic, we hope this has been a useful starting point in determining your tax entitlements. If you’d like to find out for sure whether you are in the business of property, get in touch with the property and business specialists at ABA Tax before the end of this financial year. June 30 is just a few weeks away, so call us today and we’ll make sure you’re not missing out on any eligible deductions!