The ATO recently highlighted significant non-compliance with the rules prohibiting taxpayers claiming travel expenses related to residential rental properties.

Late last calendar year, the ATO revealed that it had identified 26,000 taxpayers who had incorrectly claimed deductions for travel to rental properties during tax time 2018, despite recent changes to the law in this area.

New rules, introduced just over a year ago (and therefore perhaps not ingrained in many people’s minds), mean that investors can no longer claim travel expenses relating to inspecting, maintaining or collecting rent for a residential rental property as deductions, unless they are carrying on a rental property business or are an excluded entity.

This measure was introduced to address concerns that some taxpayers were claiming travel deductions without correctly apportioning costs where there was a private component to the travel, or claimed travel costs that were exclusively for private purposes.

The changed rules mean that travel expenditure incurred in gaining or producing assessable income from residential premises is not deductible unless incurred by certain institutional entities or incurred in the course of carrying on a business.

Exclusions

The legislation is primarily targeted at individual landlords who are not in business. Travel deductions can continue to be claimed by the following taxpayers who own residential rental property:

• corporate tax entities (companies, corporate limited partnerships, corporate unit trusts, and public trading trusts)
• superannuation plans that are not an SMSF
• public unit trusts
• managed investment trusts, and
• unit trusts or partnerships where every entity is of the types listed above.

Taxpayers carrying on a commercial business of renting residential properties, such as owners of hotels, motels, boarding houses, are also exempted.

Note that the ATO’s view is that it is quite rare that individuals who own standalone residential rental properties are carrying on a business, even where they own multiple standalone properties.

This is in spite of several court case decisions seemingly giving scope to an argument that a taxpayer who owns a portfolio of standalone residential properties could be deemed to be carrying on a business, and therefore should continue to be able to claim travel expenses. However this will depend on individual circumstances, and the number of properties would need to be significant — certainly more than just a couple.

Residential investment properties

The changes apply to “residential properties”, which takes on its ordinary tax law meaning of land or buildings that are occupied as a residence and are capable of being occupied as a residence. This can include a “floating home” and commercial residential premises such as a boarding house.

Whether a property is residential in nature is determined by the property’s physical characteristics. It would be expected therefore that the property has characteristics such as kitchen facilities, shower, toilet, laundry, bedrooms and so on. However not all premises that have such facilities are residential premises to be used predominantly for residential accommodation.

If it’s apparent from the physical characteristics of a premises that its suitability for living accommodation is merely ancillary to its main function, the premises is not a residential premises for the purposes of the new rules. For example, a multiple-story office block that has open spaces for cubicles and desks, and smaller separate offices, may also contain kitchen and toilet facilities. Despite this, such premises are not residential in nature.

Note that under the new rules, where you are not using the property to derive rental income but are using it for other income-producing purposes (for example, you are using it in a business) travel will continue to remain deductible. This exception accommodates cases where residential premises are converted and used by a professional, such as a doctor or dentist, to operate their business.

Where there is a mix-use of the property, each trip to the property must be considered on its merits, and if necessary the expenses apportioned.

Capital gains

Travel expenditure that is prevented from being deducted by the new rules cannot form part of any element of the cost base or reduced cost base of residential premises for CGT purposes. Consequently, the travel expenses that are no longer recognised on a taxpayer’s revenue account are also prevented from being recognised on their capital account.

Travel expenses

The new law is broad in scope and denies deductions for not only travel to the property for the purposes of inspecting, maintaining or collecting rent for example, but also travel undertaken that’s related to the property but not to the actual property itself.

This includes travel to a body corporate meeting, or to visit the real estate property manager to discuss the property, or travel to buy and install assets used in the rental property. The prohibited deductible travel expenditure under the new rules includes:

• motor vehicle expenses
• taxi, Uber or hire-car costs
• airfares
• public transport costs, and
• meals and accommodation related to the travel.

All is not lost

A question that may be exercising investment property owners is whether travel to see a tax agent is deductible when preparing a tax return in relation to a residential property’s income and expenses.

The good news is that the new law does not apply where travel expenses are incurred to visit a tax agent for the purposes of preparing and lodging an income tax return that happens to include rental income and deductions. This is because such expenses relate to the management of your income tax affairs (which is made specifically deductible under the existing rules), and not to the gaining or producing assessable income from the use of residential premises for residential accommodation.

Considerations going forward

Virtually all travel related to earnings from residential rent – provided that it is not as part of a business – is now denied a deduction, and is not claimable under other provisions of the tax rules.

You can still claim a deduction for the cost of employing other parties to carry out tasks on your behalf. This includes enlisting real estate agents to carry out property management services, such as inspections, or hiring tradespeople for repairs and/or maintenance. Indeed, where the travel expenses are significant (and now no longer deductible) it may be a smart option to consider engaging the services of these other parties.