Renting to a relative at below market rental rate?

[Ed Barton]

Renting to a relative (let's call him Cyril) at below market rental rate, but not making a loss.

This question comes up from time to time but usually has the property making a loss. Usual question is can I offset this loss against other income? - Answer, generally no, you'd need to apportion.

My situation is a little different. I don't borrow to invest, so I have no interest deductions on properties. So if I buy a property for Cyril to rent (or rent him one of my existing properties) and the property is not making a loss are all the normal deductions claimable?

e.g.:

• $400k property. Market rent $400pw/$20,800pa.
• Expenses/deductions (rates, water, depreciation, a bit of maintenance) = $4k pa
• Cyril pays me $100pw/$5,200pa rent.

Would I pay tax on $1,200 (5200-4000), or would the deductions be reduced because I wasn't charging market rent?

cheers

 

[BMan]

how much below market rent are you charging
if your not paying an REA you could probably rent 10-15% below market rent and still end up the same.

 

[tobe]

Id say if you arent charging market rent, then you cant claim any expenses, and you should be paying tax on the rental income you receive. Id keep good records of the rental income cause later on the ATO might audit and ask you to pay tax on the market rental if you cant prove otherwise.

 

[baby blue eyes]

Look on the ato website, it is clear. Rental props booklet gives examples , you are still trying to avoid tax by renting below market rate but claiming 100% expenses, seriously Seek tax advice

 

[Ed Barton]

Id say if you arent charging market rent, then you cant claim any expenses, and you should be paying tax on the rental income you receive. Id keep good records of the rental income cause later on the ATO might audit and ask you to pay tax on the market rental if you cant prove otherwise.

If that was the case I wouldn't bother charging Cyril any rent.

After referring to the ATO guide to rental properties and reading the non commercial rental arrangements tax ruling I'm confident that is not case.

 

[Ed Barton]

Look on the ato website, it is clear. Rental props booklet gives examples , you are still trying to avoid tax by renting below market rate but claiming 100% expenses, seriously Seek tax advice

Thanks BBE.

Firstly I'm trying to provide somewhere to live for a relative who is down on their luck. Of course I would be trying to avoid tax, but certainly not evade it.

Yes it is clear...

Generally, a deduction can be claimed for rental property expenses up to the amount of rental income received from this type of non-commercial arrangement. - ATO rental property guide p.8

Of course I would check with my accountant.

 

[jrc]

Ed, you can rent to Cyril below market and show the rent as income and claim the expenses as long as the income exceeds the expenses. If the expenses exceed income you are limited to claiming for expenses to an amount equal to the rent. Presumably in those years the excess expenses might be added on to your cost base.

Yes keep good records so that you can substantiate the rent cyril is paying you.

It's great that you are set up so that you have the ability to help cyril.

Enjoy!

 

[A Jeremy]

I could be wrong but as far as I know, if a company owns a property and allows a board member or employee to live there for free, they are liable to pay tax on the market rent value. I imagine it's the same for any entity.

Someone please correct me.

 

[jrc]

I could be wrong but as far as I know, if a company owns a property and allows a board member or employee to live there for free, they are liable to pay tax on the market rent value. I imagine it's the same for any entity.

Someone please correct me.

This relates to Fringe Benefits Tax. It is not going to affect Ed if the house is in his name and he rents it to Cyril unless Cyril is an employee. Ed has said Cyril is a relative, presumably that is why he has chosen to rent at below market due to familial feelings, loyalty etc.

 

[wylie]

Friend of mine bought his family home from his parents, when the parents divorced, and his father moved out. His mother lived in the family home at a much reduced rent (about one quarter from memory).

He paid tax as if he was receiving full rent, even though he was receiving only about a quarter of market value. I cannot remember if he is claiming anything much as interest or expenses on this old house, but I do recall very clearly him saying he must pay tax on what he would receive if he rented it in the market, and not rent it super cheap to his mother.

Be very careful with this. He felt it very unfair to pay tax on a figure that he was not receiving, but was not prepared to be risk being caught or audited, so he did the right thing (still doing it many years later).

 

[jrc]

Friend of mine bought his family home from his parents, when the parents divorced, and his father moved out. His mother lived in the family home at a much reduced rent (about one quarter from memory).

He paid tax as if he was receiving full rent, even though he was receiving only about a quarter of market value. I cannot remember if he is claiming anything much as interest or expenses on this old house, but I do recall very clearly him saying he must pay tax on what he would receive if he rented it in the market, and not rent it super cheap to his mother.

Be very careful with this. He felt it very unfair to pay tax on a figure that he was not receiving, but was not prepared to be risk being caught or audited, so he did the right thing (still doing it many years later).

I would question whether he "did the right thing". either by himself or the taxpayers. First if the market rent exceeded his expenses, he is foolish to pay tax on money he has not received and would be in front limiting his expenses claim to the actual rent his mother is/was paying. Second, if he has made a decision for family reasons to allow his mother to rent at a reduced rate in the old family home why should he be able to claim his loss by claiming he received rent if he hadn't. in the latter case, he could rent to his mother without an agent at say 10 per cent less than market rent, give his mum the difference between what she is actually able to pay and what the rent is and then she pays him the agreed rent. It might be a matter of the form of the transaction rather than the substance, but tax laws look at how things are done.

 

[wylie]

Hi jrc. My understanding is that is what his accountant advised. I don't recall the intricacies or the details, but what you or I think has no bearing on what the ATO requires in this situation.

This friend had advice from his accountant and followed it.

 

[Ed Barton]

Hi jrc. My understanding is that is what his accountant advised. I don't recall the intricacies or the details, but what you or I think has no bearing on what the ATO requires in this situation.

This friend had advice from his accountant and followed it.

I'd be getting a second opinion and I would be advising your friend to also do so.

I can't see anything in the rental property guide (http://www.ato.gov.au/uploadedFiles/Content/MEI/downloads/ind00342353n17290613.pdf) or ruling on non commercial rental arrangements Taxation Ruling IT 2167 (http://law.ato.gov.au/atolaw/view.htm?DocID=ITR/IT2167/NAT/ATO/00001) that even hints at what you are saying.

The tax boffins on this forum must be away today, but I'm sure they'll comment when they get a chance.

 

[Ed Barton]

Presumably in those years the excess expenses might be added on to your cost base.

Thanks JRC. Do work in the field of tax?

I hadn't even considered CGT, but yes, you could be right. CGT is something for my heirs to be concerned about.

 

[datto]

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A private ruling might be the go. The above quote was from the ATO rental booklet.

I always thought that where a property is leased to a relative at below market rate, then all deductions are apportioned.

In your case you are charging rent at 25% of the market rate, then all deductions are reduced to 25% of their full amount. If this still makes the property negative geared, then so be it. This is my opinion.

 

[wylie]

I'd be getting a second opinion and I would be advising your friend to also do so.

The tax boffins on this forum must be away today, but I'm sure they'll comment when they get a chance.

I am thinking now back to the conversation, and it is more likely that in order to claim the interest on the loan they had to treat as income what the market price for the house was. I'm guessing if they weren't claiming any interest it might not have mattered.

These are savvy investors, with several IPs, very high paying profession (him) and I'm sure they would have looked into this before just paying more tax than they needed, but it will be interesting when an accountant can enlighten us.

 

[Tillie]

I am really interested to read the answers, so. Vacant help my friend. My friend is about to kick out her tenant and let her mother to rent her IP below the market rent. Her agreement is that her mother will only pay the mortgage (interest only) and they will pay all other costs, council rates, water rates etc. She has not even given any thoughts for the taxation matters. Previously her IP was negatively geared after depreciation, but not by much.

 

[Ed Barton]

A private ruling might be the go. The above quote was from the ATO rental booklet.

I always thought that where a property is leased to a relative at below market rate, then all deductions are apportioned.

In your case you are charging rent at 25% of the market rate, then all deductions are reduced to 25% of their full amount. If this still makes the property negative geared, then so be it. This is my opinion.

That may be your thoughts but it is not supported by the rental booklet or the tax ruling. FWIW they were my thoughts before investigating it.

It's far from certain that I will go ahead. If I do I'll let the forum know the accountants, and or ATO advice.

I doubt a private ruling will be necessary - it must be a relatively common and well established principal.

 

[Ed Barton]

I can't think of another area where tax would be payable on what income 'could' be earned rather than what was actually earned.

• Would a hotel have to pay tax on 80% occupancy when it was only 20% full - no
• Would a plumber who charges $50 per hour have to pay tax on $100 per hour - no
• Would a restaurant that only earned $2k pw have to pay tax on the industry standard of $5k pw - no

Tax is not payable on income that is not earned. However it may result in a 'please explain', or even a full rubber gloved audit from the ATO.

 

[BMan]

a plumber that charges $50/h haha nice joke