At this time of year many Perth families travel down south. The idea of buying a holiday home always comes to mind.
And once you look at the costs of owning a holiday home Perth business families always think about the tax outcome of buying holiday homes. Because if a holiday home becomes tax deductible you can afford double the purchase price of your home.
So that could the difference between a quaint cottage to a decent home 4 x 3 on a large block with views.
The basic scenario
If you buy a holiday home to live in, as a holiday home the costs of buying and owning the home are not tax deductible. So any money spent on maintaining the home will come from after tax dollars.
Importantly however is the capital gains tax implications. If you sell a holiday home later on down the track the sale will most likely be a taxable sale.
Tom buys a holiday home in Yallingup in 2001 for $370k. He travels from Perth to Yallingup for regular holidays. He sells Yallingup in 2018 for $970k.
The $600k profit is potentially subject to capital gains tax.
Importantly however the costs of owning the holiday home will form part of the tax cost base of the property. They will form part of the “third element of cost base” as detailed in s 110-25(4).
These costs of owning the property can include:
1 Interest on money borrowed by the taxpayers to acquire the asset.
2 Costs of maintaining, repairing, or insuring the asset.
3 Rates and land tax
4 Interest on moneys to refinance a borrowing to acquire the asset.
5 Interest on moneys to renovate the asset.
So while the costs incurred in buying and owning the home are not income tax deductible now; they might eventually become tax deductible for capital gains tax.
Tom buys a holiday home in Yallingup in 2001 for $370k. He sells it in 2018 for $970k.
Over 18 years Tom has incurred $500k in interest, land tax, repairs and shire rates.
The $100k profit is potentially subject to capital gains tax.
The important part in this instance is that you record these ongoing costs with your holiday home. Quite often Perth business families leave the costs of owning the property in a big mess – and when confronted with the same question as Tom did above – all records are lost. So the tax benefits are missed.
This is more difficult when the owner has passed away.
So even for a basic case scenario it is critical to properly account for a holiday home. This is where a trust structure is helpful as a trust will prepare financial statements each year for the trust and the costs incurred in maintaining the home can be tracked.
The partly tax deductible scenario
Quite often the holiday home becomes a white elephant. The family use the home 26 times in the first year of ownership, 13 times in the second year, 6 times in the third year of holding it and in the fourth year of owning the property the kids go to it over Easter.
At this stage somebody in the family will typically think of putting the holiday home onto Air BnB and collecting some rental income from it.
If a holiday home generates rental income the income will be taxable to the owners of the property according to their ownership share.
Tom and Doris live in Perth and own a property in Yallingup (Tom 60% and Doris 40%). It is worth $970k and has not been used in the last 12 months.
Zane (Tom’s son) cleans the property up, advertises the property on Air BnB, meets the guests, does exit cleans and all things necessary to earn the rental income.
Zane collected $27,000 in rental income.
The rental income is assessable at $14,400 to Tom and $9,600 to Doris.
If the property is partly tax assessable then the costs of owning and maintaining the property can also become partly tax deductible.
As a general guide the tax deductible use of the property should be done with reference to the time the property was rented, or was actively available for rent (Taxation Ruling IT 2167).
Paul lives in Perth and has a property at Dunsborough. Paul has the property listed with an agency for short-term rental for 10 months of the year. However, over January and February Paul holds the property for his family to use as a holiday home. The real estate agent only manages to rent the property for 6 of the 10 months during which the property is available and listed for renting. Paul would be entitled to claim interest deductions in relation to the 10 months during which the property was ready and available for rent.
It is important to note that the approach is generally accepted. Some holiday homes, like those in say, a ski region, are only occupied during a short period. And using the time basis to determine the private component is not necessary appropriate – so the Tax Office have effectively left “wriggle room” in their tax ruling if the system is abused.
To the extent that the costs of owning a holiday home are claimed as a tax deduction those same costs cannot be used to form part of the tax purchase price when the property is sold.
The fully tax deductible case
If the holiday home is rented to the world at large for the whole financial year; then the tax law applicable to the holiday home is the same as it is for any rental property.
Leasing the home to associates and family
If the property is leased to a family member at commercial terms the tax outcome is the same as if it was leased to a third party.
Paul has listed a property in Dunsborough. The real estate agent has indicated that Paul will receive $900 a week for the property.
Paul’s brother Malcolm approaches Paul. He has agreed to pay Paul $900 a week in rent and Paul terminates the real estate agency.
Malcom lives in the property and makes it his home. He signs a lease and pays the rent to Paul at least monthly.
Paul can claim a tax deduction for the ongoing holding costs.
The primary tax concern is where the property is not let to family members at commercial rates or if the agreement to rent is essentially a sham.
The current approach by the courts is to determine the facts of each case and make an objective decision on the facts. There is no one factor that affects the tax outcome.
Paul lives in Perth and he owns a property in Dunsborough that is listed with a real estate agent. The real estate agent has indicated that Paul will receive $900 a week for the property.
Paul’s brother Malcolm approaches Paul. He has agreed to pay Paul $900 a week in rent and Paul terminates the real estate agency.
Malcolm has never visited the property. However, Paul regularly accesses the property in his capacity as a family member of Malcolm.
In this instance it is difficult to see a genuine lease. It might be that Paul’s tax deductions are limited to the $900 a week in rental income.
There are also tax cases where an entity, like a family trust, has purchased a holiday home and rented it to the family. These cases are possible and require a significant amount of care and attention to ensure that the tax deductions will stand up as intended.
Land tax
Holiday homes are subject to land tax. Given that land tax rates in Perth and Western Australia are marginal rates; the ongoing acquisition of property by an owner can make a significant difference to the land tax outcome of owning a holiday home. The marginal rates cover property that is both within Perth and regional Western Australia.
Tax strategies exist to minimise the land tax impact if this is a concern.
What is certain is that the purchase of a holiday home is a significant decision to a Perth business family. At Westcourt we offer a consultation on the tax impact of buying a holiday home, financial modelling to understand the after tax weekly cost to a family and a detailed report on the same. The consultation is around one hour, plus the detailed financial model, plus registers for future cost control is $900 plus GST and it is tax deductible.
