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1 Are the losses and outgoings incurred for the Forest Lake rental property deductible under paragraph 8-1(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)?

1 Yes. Question 2 Are you excluded from deducting the expenses in part as they are a loss or outgoing of a private or domestic nature under paragraph 8-1(2)(b) oftheITAA 1997? Answer 2 Yes. This ruling applies for the following : Year ending 30 June 20XX The scheme commenced on: 1 July 20XX

Acquisition of Property You purchased the property on XX/XX/20XX for $XXX as the primary residence. The property is a X-bedroom, X-bathroom residential property with a single lock up garage on XXX sqm villa block. In 20XX, you relocated for personal reasons and began renting a different house and kept the property as a long-term investment. The property was rented for XX years with the first tenant renting the property for X years and the second tenant was your sibling. You refinanced the owner-occupier mortgage with a Bank into an investment loan with another Bank (initially interest only, and then transitioning to P&I after a few years). The mortgage has been maintained as an investment loan as part of a "wealth package" with this bank continuously since 20XX. In 20XX, you obtained a depreciation schedule for the property from XXX. First Tenancy In 20XX, the property was first rented by a real-estate agent at $XXX per week. This was compared with another property XXX. This is a X-bedroom, X-bathroom, single lock up garage, same block size also with split system air conditioning which was advertised at $XXX per week in 20XX.

Actual rent was $XXX per week, you received $XXX per week after management fees. You paid the full water & sewerage costs. Second Tenancy In 20XX, you rented the property to your sibling for $XXX per week. This was compared with another property XXX which was listed for $XXX per week in 20XX. You reduced the rental to account for not using the property manager by XX% of the gross rent plus postage and sundries to $XXX. A fixed XX-month term tenancy agreement with another XX months extension and now is under periodic tenancy arrangement to date. You are still paying for the water and sewerage charges. Investment Strategy The strategy in retaining the property as an investment was to hold it long term, discharge the mortgage, and then to retain the property either as an income stream for retirement or to be sold at retirement. This was originated because you did not have superannuation at the time of purchasing the property. To mitigate the risk of losing the property, the strategy was consistently having the property tenanted until the mortgage was discharged. As such, you have always prioritised minimising vacancy risk, over and above increasing immediate return.

Current "Market" Rent You have been monitoring the value of the property and the rental holding costs with a long-term focus. Following Covid, both property values and rental yields in Forest Lake increased. When rents began to rise in 20XX, you reviewed the investment strategy and consciously decided to stick to your original strategy of not raising the rent during a continual tenancy. The property has now more than doubled in value and yet has required minimal investment from the you in terms of either repairs or time.

Income Tax Assessment Act 1997 section 8-1 Income Tax Assessment Act 1997 section 6-5

Question 1 Are the losses and outgoings incurred for the Forest Lake rental property deductible under paragraph 8-1(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997)? Summary The losses and outgoings are deductible under paragraph 8-1(1)(a) of the ITAA 1997 as they were incurred in gaining or producing your assessable income. However, this is subject to the exemption under section 8-1(2)(b) of the ITAA 1997 that disallows any portion that is private or domestic in nature. Detailed reasoning Section 8-1 of the ITAA 1997 sets out the general rules for deductibility under the Act. The 2 positive limbs of the provision are contained in subsection 8-1(1) of the ITAA 1997, which provides that you can deductfrom your assessable income any loss or outgoing to the extent that: a)             it is incurred in gaining or producing your assessable income, or b)             it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

The 4 negative limbs of the provision are contained in subsection 8-1(2) of the ITAA 1997, which qualifies the application of the positive limbs by providing that you cannot deduct any loss or outgoing under section 8-1 to the extent that: a)             it is a loss or outgoing of capital, or of a capital nature b)             it is a loss or outgoing of a private or domestic nature c)             it is incurred in relation to gaining or producing your exempt income or your non assessable non-exempt income, or d)             a provision of the Act prevents you from deducting it. If the expense cannot satisfy either of the positive limbs, the expense will not be deductible under the general deduction provisions. Therefore, the first step in determining if an expense is deductible under section 8-1 of the ITAA 1997 is to apply the positive limbs. The second step is to confirm the expense does not qualify as a negative limb cost which disallows the deduction. A taxpayer must incur the rental costs with a clear connection to the gained income.

In determining the deductibility, consideration is made to the connection of income being earned under section 6-5 of the ITAA 1997 in allowing a deduction under section 8-1 of the ITAA 1997. Nexus of income to the deduction Section 6-5 of the ITAA 1997 provides that the assessable income includes rental income earned as a result of renting out your property, or part of your property. In your case, you have used your home to provide accommodation to your sibling. You have reduced the rent to an amount below market value. You have advised that the intention of providing the accommodation is to make a profit. However, this will be subject to the exemption under subsection 8-1(2)(b) of the ITAA 1997 that disallows any portion that is private or domestic in nature. In FCT v Kowal (1983); 79 FLR 75; 15 ATR 125; 84 ATC 4001 ( Kowal's case), the taxpayer was renting to a relative at below market rate. The Court found that the taxpayer had two objectives in mind. One was to provide his relative with a good home at moderate cost. The other was to earn assessable income. The Court determined that the rent was assessable income.

Therefore, since the rental income is less then market value, you can only claim deductions equal to the amount of rent received during the income year. Question 2 Are you excluded from deducting the expenses in part as they are a loss or outgoing of a private or domestic nature under paragraph 8-1(2)(b) oftheITAA 1997? Summary Not all the losses and outgoings incurred are deductible; you can only claim deductions equal to the amount of rent received during the relevant period. You need to apportion the expenses for both private and income-producing use because the rental income received is less than normal commercial rates. Detailed reasoning Subsection 8-1(2) of the ITAA 1997 provides under general deductions that there must be a link between an outgoing and the production of assessable income. However, you cannot deduct a loss or outgoing under this section to the extent that: a)             it is a loss or outgoing of a private or domestic nature. These private expenses are the negative limb of section 8-1 of the ITAA 1997. This is not a positive limb because the connection required for an expense to be deductible to the extent

that they are incurred in earning assessable income link is broken. The phrase to the extent indicates that some expenses may need to be apportioned when they are partly used to earn income, and another use is private. In determining whether a particular receipt is income in a rental property, consideration needs to be given as to whether the intention of providing the accommodation is to make a profit or a genuine commercial relationship exists between the parties. Non-arm's length arrangement Taxation Ruling IT 2167 Income Tax: rental properties - non-economic rental, holiday home, share of residence (IT 2167) discusses arm's length and non-arm's length letting of a residence. Generally, the approach to be followed is based on whether the rent charged by the owner represents a normal commercial rent. Paragraph 14 of IT 2167 states that while less than commercial rent can represent assessable income, it would not necessarily follow that, losses and outgoings in relation to this are wholly deductible. The normal commercial practice would be that a property is rented primarily for profit.

In your case, there is a formal agreement between you and your sibling at a rent charge below market rates. The outcome of your arrangement is different to what it would be if the parties were not related or connected in some way. The decision to reduce the rent was a goodwill gesture and therefore there is a purpose other than income production. Paragraph 15 of IT 2167 provides guidance on letting of property to relatives, in the Groser case, the Court expressed the view that, if the weekly rental had been assessable income, it would have allowed no more than $104 by way of deduction - the reason for this being that private or domestic purposes for the expenditure predominated over the purpose of producing assessable income. The Rental Property Guide 2025 outlines under Non-commercial rental that: "If you let a property, or part of a property, at less than normal commercial rates, there may be a limit on the deductions you can claim. For example, your deductions may be limited to the amount of rent you receive for any period you rent your property for less than normal commercial rates."

The guide further provides an example 14 which outlines the treatment of the private use by owner and when the property is rented to relatives. This is paraphrased below: Kelly and Dean bought a holiday home, and it is advertised through a real estate agent for rent. The market rate was $840 per week but this was rented out to their friend at $200 per week. Kelly and Dean receive income and incurred expenses, but they are only allowed to claim the expenses based on the proportion of the received income. This is because the property was rented at less than the market rate and the expenses are more than the expenses incurred. Other court cases and significant court decisions have determined that for an expense to be an allowable deduction, there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. FC of T , (1949) 78 CLR 47). In your case, the expenses above the rental income are private in nature.

As outlined above, the deductibility tests are applied - the first positive limb is met as the expenses are incurred in gaining assessable income. However, the second negative limb denies the deduction of the other or remaining costs because there is no longer assessable income to offset against. The nexus of the expense and the production of the assessable income is cut.