The Government announced in the 2017 Federal Budget that it would be making changes to the legislation regarding Rental Property Deductions under the guise of “reducing pressure on housing affordability”.
Last week, the government released exposure draft legislation detailing how two components of their housing affordability package are proposed to operate.
Travel expenditure for residential rental property
In the Federal Budget papers, the Government said they were concerned that taxpayers were not correctly apportioning costs, or claiming travel costs that were wholly for private purposes, as deductions against the derivation of their rental property. Whilst not specifically stated, it is believed that of particular concern are those taxpayers who had to travel large distances (e.g. interstate) for the purposes of conducting inspections or maintenance on their properties.
From 1 July 2017, certain classes of taxpayer (mainly individuals and closely held trusts) who have to travel to inspect or maintain residential rental properties will not be entitled to a deduction for the travel.
The exceptions to the above rule include:
- The intention of the legislation is that it should only apply to entities that are closely held or can be controlled by a small number of taxpayers. Peculiarly, private companies that own residential property appear to be excluded from the above, whether closely held or otherwise.The property is not residential premises (as defined in the GST Act);
- The property is considered to be residential premises, however those premises are not used as residential accommodation;
- The travel costs is incurred in carrying on a business for the purposes of gaining or producing income for the taxpayer;
- The taxpayer is:
- A corporate tax entity (a company, corporate limited partnership or public trading trust);
- A superannuation fund that is not a self-managed superannuation fund; or
- A unit trust that has at least 300 unit holders unless it is not considered to be widely-held trust.
There may also be some complications where mixed use properties are owned and leased by taxpayers such as individuals. This may require some apportionment or substantiation as to the purpose of any travel costs, as travel for the purposes of commercial premises may still continue to be deducted, whereas travel to the residential premises are not.
Real estate and management agencies will still be entitled to travel deductions on the basis that they are carrying on a business.
Further the on-charging of such costs as a management fee to taxpayers affected by the above will be considered to be deductible, notwithstanding that fee may include a component of travel costs
The proposed amendments also seek to ensure that such non-deductible travel costs are excluded from the cost base of the investment for Capital Gains Tax purposes and are not eligible for deduction as “business capital expenditure”.
Limiting deductions for plant and equipment in residential premises
As part of the suite of proposed plans to help reduce pressure on housing affordability, the Government is seeking to limit depreciation deductions in respect of ‘second-hand’ goods that are used in residential premises for the purposes of residential accommodation. The Government’s concern is that the same plant and equipment may be deducted by successive investors through obtaining a quantity surveyor’s report which estimates the cost of those items.
The same exceptions to the travel expenditure rule are intended to apply, such that excluded taxpayers, entities carrying on business and assets not used for residential accommodation remain eligible for deduction for second hand plant and equipment.
Any properties currently owned for which deductions are being claimed in respect of plant and equipment will continue to be eligible for deduction.
Taxpayers who entered into contracts to acquire property prior to 7:30pm AEST on 9 May 2017 will also be eligible to claim depreciation in respect of plant and equipment that were acquired as part of a contract to acquire the property.
However, taxpayers who acquire second hand assets or enter into contracts to acquire property after 7:30pm AEST on 9 May 2017 will not be eligible to claim a deduction for depreciation on plant and equipment. The cost of the plant will form part of the cost base of the property disposed and may be used to calculate a capital gain or loss on disposal.
The legislation considers second hand assets to be those that have been ‘previously used’ including where:
- The taxpayer is not the first entity that used the asset or installed the asset ready for use other than as trading stock; or
- The taxpayer had used the asset wholly for purposes that were not taxable purposes for an income year.
An example provided in the explanatory memorandum to the exposure draft legislation indicates that this will impact on the following purchases:
- Plant and equipment acquired as part of the property purchase (unless the property is new residential premises);
- Second hand equipment purchased from a friend and installed, however it is likely to extend to second hand purchases from website such as Gumtree and eBay;
- Use of assets currently owned and used for a non-taxable purpose, and subsequently installed into the rental property
It is unclear as to whether the purchase of second-hand goods through a retailer of such goods would qualify for a deduction under these provisions. For example, demo stock may not be considered to be held as ‘trading stock’ by the retailer. Alternatively, where the retailer deals with reconditioned items that have previously been privately owned. However, under the proposed legislation, there is a risk that such assets would not be eligible for deduction.
As is the case with the proposed travel rules, where there is a mixed use of an asset, the deduction may need to be apportioned accordingly between the use for residential premises and that use for other taxable purposes. This will also be the case where the asset is allocated to a low value pool.
Where to from here?
The release is only in draft and therefore is not yet law. Nothing will change for large trusts, retail superannuation funds and companies who are not impacted by the proposed changes.
However the legislation appears to be pushing taxpayers towards buying new equipment for their rental properties and the use of third parties in order to claim a tax deduction for travel expenses. Ultimately this may increase the cost to taxpayers of providing rental accommodation in order to ensure tax deductibility.