Accountant advised not to claim as rental

[Melbear]

Hi all

Desperately need some valued second opinions.

My friend and her husband are about to purchase a property for her parents to live in. At this stage, her parents will only be able (or are willing) to pay $170 per week. Market rental would be $350 to $400 per week. Loan will be for approx $400K. Adding in land tax, rates, water etc. will see a substantial shortfall in income versus costs.

Their accountant has advised them (a. not to go ahead) b. if they do, then not to claim it as a rental, and say that any money from the parents is a 'donation', and to add all expenses over the years to cost base to reduce CGT if (when?) they sell. This advice is because my friend works part time and earns approx $30K per year, and hubby is only in the 30% tax bracket (assume that's below $75K or thereabouts). She has said that 'It's not worth claiming it'! Oh, and if you don't claim it, you won't have to pay land tax!

Would this be a fair call, and would other accountants see any valid reason for this? I am struggling to comprehend the advice, and when I questioned my friend as to whether they would ever sell, she was undecided. Her parents are only in their 60s, so presumably will be in the house for a number of years, and even after that my friend is thinking that an IP to have while the kids are heading for Uni etc. would be a good idea. So, no real plans to sell, at which point no CGT is hardly an issue!

I think one of the accountants phrases was 'You'd only be $6000 better off if you claimed it'. I mean, WT-? To knock back $6000 when you're really going to struggle to pay for the thing is beyond my comprehension.

Any different arguments to put to my mate would be appreciated.

 

[alexlee]

Hold on, why don't they have to pay land tax? The only exemption you get is your PPOR. Just because they don't claim deductions doesn't mean it's exempt from land tax.
Alex

 

[Melbear]

I believe in the ACT if you don't rent it out you don't have to pay land tax. So in this case as the parents will be living there, then it can be claimed that they are not renting it out.

Interestingly, at lunch time another friend of mine used to rent (at a massive massive discount) from her Dad, and he's also used the exact 'donation' line from the kids to avoid it being a rental and therefore liable for land tax. Hmmm, wonder if it's the same accountant?

 

[Twitch]

The ATO will not allow all the shortfall to be claimed given it is so unrented. They will deem the income on the property to be at market rents. I think that would add weight to the accountants advice being correct

 

[Melbear]

They would have claimed that they earnt the market rent - I told them last week the ATO would deem it to be anyway. My problem is that they will have a serious cash flow issue if the place is rented at market rent, let alone at the measly amount the parents will pay. Surely ANY extra money for them would be good? I just don't get the accountant 'saving' them around $400 or so in land tax, and foregoing at least $3K tax refund? Methinks it can't be a property accountant???

 

[LynnH]

Melbear

I remember downloading from the forum several months ago a ruling on a similar case to the one you outline - I think it was posted by one of the accountants on SS(?). The determinant (from what I can remember) was the purpose of the loan, and the outcome was that the taxpayers could claim expenses (though I cannot remember to what degree). Sorry I cannot remember the details offhand - will have a look through my "to be filed" pile (mountain?) over the weekend and see if I can locate it. In the meantime, perhaps one of our knowledgeable SS accountants can provide more details??? Mry?? Julia??

(I do hope I haven't lead anyone astray here - I downloaded it because we were looking at doing a similar thing for our 'impoverished' student daughter, and I wanted to speak to our accountant about it).

Cheers
LynnH

 

[softmonkey]

please dont overlook the primary advice which was (a) not to go ahead, clearly the accountant knows more about their situation than any of us could!

consider:

9k of income which is very unlikely to rise given emotive relationship

versus

repayments of 32k and rising with every rate rise plus maintenance expenses

in effect ALL of your friend's income will go to keeping a roof over her parents head... they will only have hubby's income to themselves!!

the prop market is lean enough without cutting rent in half ... its a rotten idea sorry... bound to be many better solutions

good luck

 

[Melbear]

please dont overlook the primary advice which was (a) not to go ahead, clearly the accountant knows more about their situation than any of us could!

consider:

9k of income which is very unlikely to rise given emotive relationship

versus

repayments of 32k and rising with every rate rise plus maintenance expenses

ALL of your friend's income will go to keeping a roof over her parents head... they will only have hubby's income to themselves!!

the prop market is lean enough without cutting rent in half ... its a rotten idea sorry... bound to be many better solutions

good luck

I agree, however the deal is all but done. The parents are offloading their house in country town for maybe $200K. They are investing this money - which a FP has told them will give them 'growth' (whatever that exactly means) and income of $170 per week - hence the amount the folks are willing to contribute.

I have offered to my mates a way of investing $100K of that house proceeds that will almost cover the interest payments. Parents are not willing to give it a go. Hubby is concerned that marital relationship will not survive if they have to find all the funds themselves, not to mention that they have 3 kids of their own, and the baby is what would be classed 'a special needs' child.

Parents are now concerned that although $100K will return in vicinity of 20% income, that it will have no 'growth' (I mean, 20% is not enough!!!) and therefore other 2 sisters who are contributing zip, zero, zilch towards parents lifestyle, will dip out when they're no longer on top of this earth.

 

[alexlee]

Parents are now concerned that although $100K will return in vicinity of 20% income, that it will have no 'growth' (I mean, 20% is not enough!!!) and therefore other 2 sisters who are contributing zip, zero, zilch towards parents lifestyle, will dip out when they're no longer on top of this earth.

Are alarm bells ringing for anyone else when they heard '20% return income'? What the heck are they investing in? And how sustainable (if it isn't outright fraudulent) can that be?
Alex

 

[yo yo ma]

I think one of the accountants phrases was 'You'd only be $6000 better off if you claimed it'. I mean, WT-? To knock back $6000 when you're really going to struggle to pay for the thing is beyond my comprehension.

What they may mean is they may be $6k better off now but the property will be subject to CGT when they sell so may be better to not claim it???

Have a look at p8 of the ATO guide to rental properties. It goes into detail about what they can & can't claim when renting to a family memeber at a reduced rate.

 

[Melbear]

Are alarm bells ringing for anyone else when they heard '20% return income'? What the heck are they investing in? And how sustainable (if it isn't outright fraudulent) can that be?
Alex

Kicks self in head for assuming that this wouldn't become the focus of the thread!

 

[yo yo ma]

Are alarm bells ringing for anyone else when they heard '20% return income'?

Yes... Increased return = increased risk. Are they prepared to potentially lose money?

Understand the risk/return trade-off
A general rule of investment is, the greater the risk, the greater the potential return. Greater risk may not mean the total loss of capital, but merely the volatility of returns over the investment period. Therefore, if you are prepared to invest for the longer term, you should be prepared for some volatility in expectation of higher returns. Remember, there's no such thing as a free lunch!

http://www.whittakermacnaught.com.au/content/ten_commandments.shtml

 

[alexlee]

Bit of a doom and gloom scenario, but I'm just thinking if your friend's parents lose money on their 'safe' 20% return investment, then they can't even pay the low rent on the house. Then your friend runs the risk of not being able to pay the mortgage and...... you see where I'm going with this.
Alex

 

[Melbear]

Absolutely I see where you are going with this, however that's an issue for another thread altogether. I'm trying to find out where my mates stand from a taxation perspective, and what would be best for them assuming that the parents can and do only pay $170 per week in rent.

 

[Mry]

It would be hard to comment on the situation because I don't have a clear look at the expenses that the property incurs, but if it is at market, that is very strange advice.

Note that if that the ATO won't deem that they charged market rate rent - if they charge under market, they simply won't be able to claim a negative gearing loss. They can charge market rate rent minus what the property agent would charge.

I could see why they might have that position - if the property was from a tax perspective was positively geared. Then they could capitalise the expenses instead of paying tax on income received. But while it is negatively geared, why forego the refund? Why sacrifice cash right now for some future benefit?

Doing some figures off the top of my head, I'd say the future benefit is more costly than the present benefit. If the house was lets say $350k and the cash loss was $17,000 ($18k rent - $35k expenses) in the husband's name which gives rise to a $6,000 tax benefit, if the person capitalised those $35k instead of claiming the tax loss, it would offset the capital gain in the future by $17,500 (I presume they will get the discount which at their rate of tax would save them 31.5% of $17,000 or $5,512.50. In the future. Probably worth $4,000 in today's dollars.

Granted the capital gain might throw them up into a larger tax bracket which would cost $8,137.50 at the highest rate, but that's in the future, when they have money from the sale.

This is all conjecture of course and I am making assumptions, but that's all I can go on.

Also, I have no idea about land tax in the ACT.

I would be tempted to get a second opinion, or to at least get the accountant to explain things a bit better.

 

[Melbear]

Thanks Mry. At least gives me some idea why the advice may have been given as it was. Guess I'll ask them a few more questions about what they told the accountant was happening, and then show them some figures based around your example.

 

[Pushka]

I think the ATO would say the purpose of the loan is to provide cheap accommodation for the parents, and not as income producing, so no write off.
In SA, it doesnt matter whether the second property produces an income or not - you still pay Land Tax. So people who have held a beach shack (some for several generations) are being slugged several thousands of dollars every year because most of these are in coastal areas and have gone up in value.

 

[Melbear]

I think the ATO would say the purpose of the loan is to provide cheap accommodation for the parents, and not as income producing, so no write off.
In SA, it doesnt matter whether the second property produces an income or not - you still pay Land Tax. So people who have held a beach shack (some for several generations) are being slugged several thousands of dollars every year because most of these are in coastal areas and have gone up in value.

If the agreement is to pay the market rent (less managing agent fees) then it wouldn't be 'cheap accom for parents' so why would the ATO then decide that it was? On what basis? There's no tax law against giving your parents money every month - because you can - to help them pay rent, is there? Surely that's what they could claim they are doing?

I rent from my parents at the moment, and pay what the previous tenants were paying - Mum and Dad are even in front cos now there's no agent. Although I do expect a rent hike at end of 12 months

 

[Pushka]

There's no tax law against giving your parents money every month - because you can - to help them pay rent, is there? Surely that's what they could claim they are doing?

True, but your friend is the Landlord not just a nice son who is helping out his parents! And will then go on to claim investment expenses on tax. Also, I would be a bit worried about telling the ACT Revenue Office that it wasn't rented out, to avoid paying Land Tax (if that is the system there). That is fraud and I reckon they may just find out about it one way or another.

 

[Melbear]

True, but your friend is the Landlord not just a nice son who is helping out his parents! And will then go on to claim investment expenses on tax. Also, I would be a bit worried about telling the ACT Revenue Office that it wasn't rented out, to avoid paying Land Tax (if that is the system there). That is fraud and I reckon they may just find out about it one way or another.

My friend can indeed be a nice daughter helping out her parents. ACT Land Tax Act 2004 says that land tax is due only when a property is 'rented'. If the property was bought for parents to live in it, with no rent payable, then there will be no land tax payable either.

You obviously misread my post, cos the accountant has advised them NOT to claim any rental expenses whatsoever on tax, but merely to add all expenses to capital cost for when and if time came to sell. Therefore there can be no fraud.

Don't confuse ACT where there is $0 land tax threshold with other states that allow you to own $x,000 worth of land before they'll hit you with land tax, no matter if it's just a massively expensive PPOR or not.