During the COVID pandemic Brandon bought a weekender property in MacMasters Beach. Brandon is busy running his business out of a chambers in Sydney and has the property listed on AirBnb any time rental. He intends to keep the property as a long-term asset but would like to continue to earn rental income. It is in effect part investment property, part lifestyle weekender retreat.

Given the mixed use of the investment property, Brandon would like to gain greater clarity around the income tax implications he faces, particularly with respect to the income tax treatment on rental income and expenditure.

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We have a wealth of experience assisting clients with Capital Gains Tax (CGT), tax deductions on "mixed use" investment properties, and the general tax obligations and tax consequences that can come with owning a second property.

If you're thinking of purchasing an investment property or have already purchased one and need help beyond the common tax deductions we would love to meet you for a complimentary call.

Rental income and expenses

Brandon's MacMasters Beach house is a special type of investment property as it is used to generate rental income while he and his immediate family also have personal use and enjoyment of the property. This aspect is important, because it relates to a tax law principle that a domestic or private portion does not give rise to a tax deduction.

Any rental income received is included in Brandon's assessable income. He can also claim a deduction for the expenses, including maintenance costs, however, he must ensure that he apportions expenses to account for any private use of the property.

Brandon can only claim expenses for periods that his holiday home was being rented or was genuinely available for rent (excluding periods such as when the investment property was used by Brandon, or his friends and family at no charge).

Record keeping - rental income and expenses

Rental income

When Brandon rents out his MacMasters Beach house through Airbnb, he should ensure he keeps records of all income earned and of all expenses incurred for the purpose of producing rental income. If Brandon rents out the investment property to friends or family below market rate, his deductions for that period are limited to the amount of rent received.

Brandon does not need to pay GST on the amounts of residential rent he earns.

Rental expenses

It may not be appropriate for Brandon to apportion all expenses on the same basis. For example, expenses that relate solely to the renting of his property are fully deductible, and he would not need to apportion them based on the time the property was rented out.

Rental expenses include:

• real estate commissions
• costs of advertising for tenants
• phone calls made to a tradesperson to fix damage caused by a tenant
• the cost of removing rubbish left by tenants

No tax deductions can be claimed for expenses that relate solely to periods when the property is not genuinely available for rent, used for a private purpose or relates to the part of the property that is not rented out. This would include the cost of cleaning Brandon's holiday home after he, his family or friends have used the property for a holiday or repair for damage that he caused while staying there.

During vacant periods, when the property is not rented out but is genuinely available for rent, expenses may be deductible.

Factors that may indicate a property isn't genuinely available for rent

The following factors can be used to indicate when a rental property isn't genuinely available for rent:

• the rental property is advertised in ways that limit its exposure to potential tenants, for example, the property is only advertised: at your workplace, by word of mouth, on restricted social media groups, outside annual holiday periods when the likelihood of it being rented out is very low
• the location, condition of the rental property, or accessibility of the property means that it's unlikely that tenants will seek to rent it
• you place unreasonable or stringent conditions on renting out the property that restrict the likelihood of renting out the property, such as: setting the rent above the rate of comparable properties in the area, or placing a combination of restrictions on renting out the property, such as requiring prospective tenants to give references for short holiday stays and conditions such as "no children" or "no pets"
• you refuse to rent out the rental property to interested people without adequate reasons

The above factors generally indicate the owner doesn't have a genuine intention to earn rental income from the property and may have other purposes, such as using it or reserving it for private use.

Factors that indicate when a holiday home is genuinely available for rent

The Australian Taxation Office (ATO) will expect to see signs that your holiday home is genuinely available for rent, such as:

• letters from real estate agents that had the investment property on their books, including
• when the property was listed
• the criteria used to choose tenants, i.e., were there any restrictions?
• the interest generated
• whether any potential tenants were rejected upon applying for occupancy of the property, including the reasons for the rejection
• Evidence the property has been advertised, for example, on the noticeboards of local shopping centres or in the local newspapers
• Letters from business proprietors that may have allowed the owner to advertise the property for rent within their business premises
• the owner's verbal evidence on their efforts made to rent the property

Properties that are not listed with an agent can still be genuinely available for rent.

Apportioning rental expenses

Brandon's weekender is available for rent all year round. When determining what deductions can be claimed, it's essential that Brandon apportions such deductions for any period during an income year that the property is:

• used for private purposes
• not rented to tenants, and/or
• not genuinely available for rent

In order to properly determine how much of the deductions can be apportioned, Brandon needs to keep a detailed record of the dates when the weekender is rented out.

Interest expenses are tax deductible to the extent that the private usage days have been apportioned. In Brandon's case, interest expenses were not claimed as his previous accountant did not pick them up. Brandon was able to lodge an amended income tax return with us that included the interest expense deductions.

Note there is a two-year window of opportunity to amend the income tax return (from the date your notice of assessment is issued). To learn more about notices of assessment, read our article here.

Non-deductible expenses and cost base

While the private portion of the expenses are not tax deductible, Brandon is permitted to include the costs of owning the Capital Gains Tax (CGT) asset he incurred in the cost base of the asset for CGT purposes. This would reduce any capital gain on disposal. This is only applicable to properties acquired after 20 August 1991, which is the case for Brandon, given he purchased the weekender in MacMasters Beach in 2021.

Costs can include the following:

• interest on money Brandon borrowed to acquire the asset
• costs of maintaining, repairing, or insuring the asset
• rates or land tax, if the asset is land
• interest on money Brandon borrowed to refinance the money he borrowed to acquire the asset, and
• interest on money Brandon borrowed to finance the capital expenditure he incurred to increase the asset's value

Given the above, it is important Brandon keeps records to substantiate the costs incurred and the relevant private use apportionment.

ATO crack down on holiday homes tax deductions

The ATO have formed a view that some taxpayers are exploiting ownership tax deductions on "holiday homes" in that the properties are not rented out at arm's length or not genuinely being rented out to anyone. Some taxpayers have imposed unreasonable limitations to reduce the likelihood of rental, but still seek to claim in full the tax deductions on these properties.

The ATO has written to tax agents and warned them that they intend to audit taxpayers who own rental properties.

The ATO has indicated that the key questions they will ask are:

• What is the number of days the property was rented out at market value during the income year?
• How was the property advertised for rental and what restrictions if any were placed on the rental?
• What records are kept regarding family friends and owners who use the property during a year of income?

ATO warning on "peak period" usage by owners

There are special rules wherein an owner of a rental property uses it during a peak period, such as the Christmas holidays. In situations where a holiday home is used for private purposes during peak holiday periods, that is, during periods that would otherwise generate the highest amount of rent, many holiday homeowners may seek to:

• claim deductions for property-related expenses and depreciation that relate to the off-peak periods during the year that their holiday home is listed for rent on the basis that their property is genuinely available for rent, and
• apportion their property-related expenses and depreciation on a 'time basis', e.g., deductions may be claimed for the number of days that the relevant property was listed for rental during off-peak

In the above circumstances, the ATO is likely to question a taxpayer's purpose in acquiring the holiday home. The ATO may seek to apply a different apportionment method and/or reduce a taxpayer's deductions related to their property in any of the following ways:

Limit deductions to income

The ATO may only allow property-related deductions for the year to be claimed up to the amount of any rental income derived from the property.

Time basis of apportionment may not be appropriate

If deductions are available for property-related expenses incurred during any off-peak periods that the property was listed for rent, the ATO may argue that a 'time basis' apportionment (i.e., based on the number of days a property is genuinely available for rent) is not appropriate. Instead, the ATO could argue that it may be more appropriate to calculate allowable deductions based on, for example, the amount of rent received during the off-peak periods the property was listed for rent as a proportion of the total rent that could have been received during the peak periods the property was used for private purposes.

No deductions during off-peak periods the property was listed for rent

The ATO may not allow property-related deductions that relate to off-peak periods during which the property was listed or advertised for rent in the above circumstances.

For example, the ATO may take the approach that the property is not genuinely available for rent during these periods. In this case, the ATO may only allow property-related deductions that relate to any periods in an income year during which the property was actually rented to tenants.

Next Steps

We've been helping property investors manage their tax deductions and Capital Gains Tax (CGT) on their investment properties for over twenty years. If you own an investment property but don't think you're currently enjoying the tax benefits you're entitled to reach out to us today to book a complimentary meeting to discuss becoming a client.

If you're thinking about purchasing an investment property, we can assist you with arranging finance and other borrowing expenses. We work with many fine mortgage brokers and financial advisors that we are able to recommend given our understanding of your unique circumstances.

If you're thinking about selling a property and want to understand how the capital gain may effect your taxable income, including tax payable post sale, reach out to us today.

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