Owning a holiday home near the beach, on the mountain, or on a farm is an Aussie dream for many people. It is particularly attractive to those of us who live and work close to the city, where packing up and staying at the holiday home for a short stint is a much-needed and welcomed break from the hustle and bustle of everyday life.
While you can always rent accommodation for a short stay, having your own holiday home allows you to truly create a ‘home away from home’, which is why it is a popular option
for those who can afford to buy one. On the issue of affordability, before you conclude that owning a holiday home is beyond your means, it may be worthwhile to understand the taxation implications associated with owning one first, because the potential tax benefits available may very well render this lifestyle option within your reach.
If you need the holiday home to earn some income for it to be financially sustainable, any rental income you derive from the property will be assessable income for tax purposes. However, you will also be entitled
to claim rental expenses against that income (eg, interest on the loan drawn down to buy the property), as well as other ‘non-cash’ tax deductions, such as depreciation and capital works. If the total deductions exceed the rental income, you may offset the net loss against your other income like any other rental property.
However, unlike other rental properties that are usually rented out for a longer period to unrelated parties, as you will be using the holiday home every now and then for your private enjoyment, you will need to address this private use from a tax perspective.
One way of addressing the issue is to apportion your tax deductions so that you are only claiming tax deductions that are related to the period during which the holiday home is not used by you and is available for rent. This could be a labour-intensive approach because you will need to apportion every amount claimed.
While the deductions can be claimed as long as the property is available for rent, as distinct from it being actually rented, the availability of the property for rent must be genuine. It will not be acceptable, for instance, that you merely list the property in the rental pool but you decline applications from unrelated parties to rent the property in reality. The tax office is well aware of sham arrangements and may impose penalties and general interest charges if detected.
As an alternative, where the property is owned by another entity, rather than apportioning each tax deduction, you may opt to pay rent to that other entity for the availability of the property for your private use at market value, which can easily be determined based on the amount unrelated parties are paying. In which case, you will not be required to apportion the tax deductions against the rent as the property would be taken as having always been available for rent.
You can only rent the property if the payer and payee are different tax entities. For instance, if you own the property or you and your spouse are joint owners of the property, you will not be able to pay rent to yourself.
However, one word of caution. If the entity that owns the property is a private company in which you or your associate is a shareholder, it will be highly advisable for you to pay market value rent to the company for the availability of the property to you as a shareholder or an associate of a shareholder of the company. Otherwise, the value of the property provided may be treated as a deemed unfranked dividend in the hands of the relevant shareholder or associate.
In summary, if you are in the situation of deciding whether to pay rent to the other entity (eg, it is not owned by you, your spouse, or your private company), the option you choose may result in either net income or give rise to a net loss in respect of the income year concerned. For instance, if the payment of market value rent for your private use of the property will give rise to a net income amount while not paying such rent but apportioning the rental expenses will give rise to a net loss amount, the latter may be a better option for you from a tax perspective.
To this end, be sure to enlist the help of your accountant to crunch the numbers to ensure that you are optimising your tax position.
Capital gains tax
As a holiday home is not your main residence, it will not qualify for tax-free treatment for capital gains tax (CGT) purposes. Therefore, if you sell your holiday home and make a capital gain, you will be required to pay CGT on the gain.
Provided that the holiday home is held in the name of an individual or a trust for at least 12 months before
it is sold, the capital gain will usually qualify for the 50% CGT discount (provided that the individual or trust is an Australian tax resident). As a word of warning, a holiday home must not be held by a self-managed superannuation fund (SMSF) because if a member or an associate of a member of the SMSF uses the property, the SMSF may breach the ‘sole purpose test’, which may render it a non-complying fund and entail seriously adverse taxation consequences.
On the other hand, if the holiday home is owned by a company, the company will not be eligible for any CGT discount if it sells the property.
The capital gain on the sale of a CGT asset is generally calculated as the amount by which the capital proceeds derived exceed its cost base. The capital gain may then be reduced by any current year or carried forward capital losses (subject to any applicable tax loss recoupment rules) before the remaining capital gain is reduced by any applicable CGT discount.
In calculating the capital gain on the sale of your holiday home, provided that the property was acquired after 20 August 1991, the cost base may include certain ‘holding costs’ that are not tax deductions (eg, where you have apportioned rental expenses to exclude claiming tax deductions that relate to your private use of the property), which includes the following:
• interest on money you borrowed to purchase the property
• cost of maintaining, repairing, and insuring the property rates and land tax
• interest on money you borrowed to refinance the money you borrowed to purchase the property, and
• interest on money you borrowed finance any capital expenditure you incurred to increase the value of the property.
Increasing the cost base has the effect of reducing the taxable capital gain and therefore the CGT liability, so it will certainly be worthwhile to remember including these non-deductible holding costs in the cost base of the property that are often missed.
Goods and services tax
The supply of your holiday home for rent is a supply of residential premises, which is generally input taxed. Therefore, you will not be liable to GST on the rent you receive if you are registered or required to be registered for GST. This is so even if your holiday home is a unit or an apartment that is rented out via a letting pool.
However, if it is in commercial residential premises, such as a hotel, motel, serviced apartments, etc, the rent is likely to be for commercial residential premises and therefore subject to GST.
However, as you are making an input-taxed supply, you will not be able to claim back any GST included in the expenses you incurred in the course of renting out your holiday home.
The same applies to the sale of your holiday home. As residential premises, the holiday home will not attract GST upon its sale, but you will not be able to claim back the GST included in the expenditure you incurred on the sale of the property.