Rental income and lease arrangement with a friend/relative

Hi everyone, just a general Q for today.

I have a client who received advice from a mortgage broker that she can directly rent her property to a distant cousin (not through an independent property manager) and as long as there is 3 months+ rental income hitting her bank account + the rental income is in line with the market rate, the rental income can be considered for borrowing purposes.

I am not sure if I am overthinking this one but as someone with a tax background and being emphasised the need to always deal at "arms-length", I was wondering if the above arrangement is OK? There will be a proper paper trail etc but it's interesting to learn that rental income received from a relative can be counted. Do the lenders generally extensively scrutinise lease agreement with a relative?

Thanks in advance.

 

Does your client's SMSF own the property?

 

No, it is owned directly by her in a personal capacity.

 

It's fine, regular deposits for 3 months + lease agreement will satisfy.

 

The Mortgage Broker that told them this is correct,
The property can be rented to anyone, doesn't need to be a relative.
No need for a lease agreement for the income to be included in serviceability calcs,
I've done quite a few of these where the owner has been renting to friends with no lease but regular consistent deposits into their bank account.

Technically you can even include estimated rental income in serviceability assessments while a property is vacant, usually a rental appraisal or full (short form) valuation showing the rental estimate can be used.

 

no

 

Thanks @Terry_w are you able to let me know what we need to do to make sure everything is acceptable? General in nature feedback is OK (I know lenders have different rules).

 

i would have a written lease outlining the terms of your agreement.

 

Legally/what's in the clients best interest is to have a written lease agreement, but that doesn't mean that's what the lender requires.
So what are you asking?

 

The ATO will have expectations that the owner can demonstrate on request that the rate of rent is consistent with a arms length rate and there is a regular receipt of the rent. If rent is even slightly under market you face reduced deductions. If rent isnt actually seen as paid (lets say you owe them for a bike and they are being both offset) the ATO could cancel the tax loss if there is one. State laws goes further and say it should be receipted and show the period being paid etc. A insurer will definately seek that if default occurs. Undocumented leases do arouse ATO interest when they find it and its not prohibited but does mean further checks will occur. My greater concern as a property owner would be if a lease inst a legal document both have agreed to how do you evict or enforce unpaid rent etc. Next thing you cant enforce possession and are on A Current Affair.

I stand by the view you dont sell a car to a friend and you dont borrow or lend to one either unless you wish to put the loan ahead of friendship. Same with renting. What good can come of it ?

 

I've got a few clients that let their friends or family rent a property or 2 at below market rent to help them out.
I've got a client today asking me to finance an IP purchase that they are intending to rent to their Dad because his existing lease can't be renewed and he can't find another rental. This same client has another IP they rent to their Brother and Mother.
They prefer to have someone they know in the property.
Is it the best for them financially? Probably not, but for some that's not as important as assisting people they want to help.
It's not against the law to do this

 

I feel there is nothing wrong with contracting with family or friends - but must do it in writing.

 

My 2 cents - I definitely agree with this for a number of reasons - although I'm not specifically knowledgeable about the lending assessment side of things.

In a general legal sense, not having a written and clear contract when contracting with family and friends is a bad idea.

This is more for everyone else since I'm sure Terry knows this well.

 

Its not against the law. But a % of rental deductions would be at risk. IT 2167 and other views of the Commissioner. eg
Where the information supplied in a return of income is insufficient to enable a final decision to be made, the income tax deductions allowed should be limited to the amount of rent received. Whether a further deduction is to be allowed will depend upon the nature of any additional information provided by the taxpayer.

Investment and providing social support for housing parents etc are opposing views. Its akin to suggesting claiming deductions for buying parents groceries.

Where market rates are charged then there may be no concerns

Have seen many cases where the parents are the tenants and when I hasvesought evidence rent was paid it is disclosed...not really. Then cancel all deductions and no rent is delcared. Its social housing without any impact on the tax system.

 

My point is not everyone that does this is so concerned with it.
Not all cases end up bad for the owner and if that's what they want to do then so be it, regardless of the fact that investment wise and legally it's not the best decision they could make.

Way off topic now anyway, as the lenders honestly don't care if a Lease is in place or not, just show that income is being received to a bank account regularly or heck even just a rental appraisal letter from a local Real estate is enough for some to include the rental in serviceability calcs

 

What about renting out spare rooms in a PPOR - do any of the main lenders accept that income? Going through this process now with NAB and they are not accepting it as not in previous tax returns, despite 6+ months of consistent bank deposits and formal lease agreements.

 

I totally agree. When we move, daughter and her partner will be renting our PPOR. We're covering all bases to make sure that neither of us ends up hurt (as can sometimes happen), and that the situation will be treated like any other IP. We will have a valid lease and I'm even using a PM.