In recent years, the Government has introduced rules to restrict certain deductions for landlords owning rental residential properties. The following rental-related expenses (among others) are no longer deductible:
travel expenses incurred in relation to inspecting, maintaining or collecting rent for a rental property;
depreciation on second-hand depreciating assets used in rental properties;
and holding costs of vacant land (e.g. interest expenses, council rates and land tax).
One of the exceptions to the new rules above is that they do not apply where the expenses are incurred in the course of carrying on a business. As a general rule, investors earning rental income are not classified as carrying on a business. However, there is a rare exception where a landlord can be classified as carrying on a business of letting rental properties. This classification is particularly useful to landlords who have a portfolio of rental properties that they manage themselves.
Further, landlords that qualify as a Small Business Entity (e.g. carrying on a business and aggregated turnover of less than $10 million) can also access a raft of small business tax concessions including the Temporary Full Expensing of eligible assets.
However, the Australian Taxation Office (ATO) has set a high bar for taxpayers to satisfy the requirements of carrying on a business of letting rental properties. In the ATO’s publication Rental Property 2021, the ATO provides an example where a taxpayer who owned a total of 26 properties and spent an average of 25 hours per week qualified as carrying on a business of letting properties. Further, there are a limited number of court cases that can provide guidance in this area.
That is why the recent Tribunal case (Allen and FCT  AATA 2768) will be particularly important for landlords owning several rental properties.
Allen v Commissioner of Taxation
The taxpayer in this case owned 9 properties, including 7 units in a block in Essendon. The taxpayer managed the properties himself. His duties included engaging the services of electricians, plumbers and building professionals as required, paying for repairs and maintenance, paying council rates, water rates and land tax, communicating with tenants, preparing lease agreements, undertaking property inspections, keeping records, preparing financial statements, gardening and painting. He only used real estate agents to help him find tenants. In other words, the taxpayer spent a significant amount of capital and time in managing the rental properties.
The Tribunal held that the taxpayer was more than a “passive investor” and was carrying on a business of letting rental properties. In particular, the Tribunal found the following decisive factors in the taxpayer’s favour:
the capital invested was a sizeable sum of $6 million including debts;
the fact that the properties were only geared (debt to market value) to 37.5% was consistent with a profit-making intention;
the time spent in managing the properties was significant; and
the record-keeping was consistent with being in a business-like manner, including the preparation of an “income and expense account”.
There is no bright-line rule in relation to carrying on a business of letting rental properties. However, some of the more important factors that may tip the scale in the taxpayer’s favour include:
The number of properties owned by the taxpayer. While the ATO’s preferred number is closer to 26 properties in the example provided in its guidance, the recent Tribunal case demonstrated that it was possible to qualify with a much lower number of properties (e.g. 9 properties).
The degree of involvement of the taxpayer in managing the properties. The more hours spent by the taxpayer in a week, the more likely it is that the activities qualify as a business.
The capital invested by the taxpayer. This factor is closely related to the number of properties owned by the taxpayer as well as the level of gearing of the properties.
The record-keeping of the taxpayer. The record-keeping must be “business-like” (e.g. organised and systemised).