Renting to family below market rate - how to apportion tax?

[Propagate]

Hi all,

I understand there's nothing inherently wrong with renting to family below market, and understand that there are implications tax wise.

From what I've read, as long as the ATO are not 'diddled' out of tax they would otherwise receive then it is acceptable?

My understanding is that if you rented out for say 25% below market, then the deducable expenses would also need to be appropriately apportioned to reflect this?

According to my sums, if we purchased an IP for mid $300k, rented at $330 ish a week and pay 10% agents fees, we'd be out of pocket t the tune of about $400 per month.

If we 'sack' the agent as we would not need agent when renting to family, we could reduce the rent to around $280 and still come out with the same out of pocket per month, thereby the ATO still gets the same, we're out of pocket the same but the family gets a reduced rent; the only loser is the agent who no longer gets a cut.

Is it that simple? I'd love to hear from anyone that currently rents out a property below market for whatever reason, and can shed some light on how to appropriatley approtion expenses.

Thanks.

Tone.

 

[wylie]

I have a friend whose son bought his mother's home due to her not being able to afford to keep it. She rents it back at a low sum but they are assessed for tax purposes as if they are receiving market rent. I suppose some would not be as honest, but they want to sleep at night knowing there will be no audit finding them owing a lot of back taxes.

 

[Ed Barton]

I read a Noel Whittaker article a while back that said you can rent slightly below market to family and the ATO would be fine with it. Can't remember the exact reasoning. Although I would see an accountant.

Determining market rent is not an exact science. I doubt the ATO's alarm bells would ring for propate's example. If you were renting for $150 they definitely would.

 

[marg4000]

My understanding is that if you rent to a family member significantly below market rent then you can only claim deductions up to the amount of rent received, i.e., no negative gearing.

Then again, things may have changed - an accountant would have up to date knowledge.
Marg

 

[vaughan]

Best info is here:

http://www.ato.gov.au/content/00313554.htm

 

[GaryT]

You are required to charge "market rent". However it is common to charge 10% below market rent for a good long term tenant. If the tenants are very good, look after the place well, pay the rent on time direct debit to your account such that you do not need to employ a commissioned agent, then you may look at reducing the rent a further 10%.

The ATO covers this situation in IT 2167 which refers to Kowal’s case. To cut a long story short, the judge found that 80% of the expenses were deductible against the rental income.

But what the judge also said in Kowal’s case was that should the 80% of expenses be less then the rent than the taxpayer could claim up to the amount of the rent or total expenses whichever was the lesser. So according to Kowal's case, renting to relatives, at worse, will mean the property can only breakeven, not actually be negatively geared.

So it is generally accepted that it is better to charge arms length rental (which could be up to 20% below market value) to allow you to negatively gear the IP.

 

[Propagate]

You are required to charge "market rent". However it is common to charge 10% below market rent for a good long term tenant. If the tenants are very good, look after the place well, pay the rent on time direct debit to your account such that you do not need to employ a commissioned agent, then you may look at reducing the rent a further 10%.

The ATO covers this situation in IT 2167 which refers to Kowal’s case. To cut a long story short, the judge found that 80% of the expenses were deductible against the rental income.

But what the judge also said in Kowal’s case was that should the 80% of expenses be less then the rent than the taxpayer could claim up to the amount of the rent or total expenses whichever was the lesser. So according to Kowal's case, renting to relatives, at worse, will mean the property can only breakeven, not actually be negatively geared.

So it is generally accepted that it is better to charge arms length rental (which could be up to 20% below market value) to allow you to negatively gear the IP.

Thanks for the info and links. I guess I need to know what the ATO would determine to be significantly below market rent. To be honest, we'd probably be looking at 80% plus of what the agents would suggest as market rent anyway, but who knows if this is close enough to market to be not considered "substantially below".

My worry now is that, after reading those links, is the market rent part a moot point if you are renting to family anyway? i.e. even if we charged them market rent, can we only claim expenses up to the amount of the rent and not negative gear due to them being family. How do you make it arms-length without hiring an agent that you don't need, or divorcing your parents? Or, does charging at or close to market rent thereby make it arms length regardless of the kinship?

Thanks.

 

[tobe]

just keep it arms length, and at market rent. theres nothing stopping you from gifting your relatives money from time to time, seperately. gives you the same result Id suggest, but keeps the tax office happy.

 

[Propagate]

Reading IT 2167 again, it would seem we'd be fine with just a small reduction in rent, i.e. the cost of the agent fees. This would seem to be broadly in line with market rent and thereby not "substantially" discounted, and be at arms-length as defined by being close to, or equal to a commercial rent agreement.

As for what can be deducted, it looks like that comes down to the intention of thep roperty purchase at the outset. I.E, whether it is purchased to provide a "cheap" home to family, or purchased as a genuine investment. In our case, it will be purchased as a genuine investment. Emma's parents are in and out of NZ, Oz and the UK and, although looking to settle for a little while here in Aus, they wont be here permanently or necessarily settle in the same area that we will buy. In the short term, they would live there at slightly reduced rent, but when they move on it would be rented on the open market. Similarly, should the situation arise down the line where the house is empty and they are back here, they would likely rent it again...so on and so forth, (alternately, we'd be looking at another IP by the next time they are through this way and they may use that one instead).

First and foremost, it will be a genuine IP, not a house purchase to give a cheap home to rellies.

Thanks.