Tax Tip 409: Renting out an Australian Property while a non-resident – Taxation of Rent

What happens if a person owns a property in Australia and then becomes a non-resident for tax purposes – how is the rent taxed and what happens if the property is negatively geared?



Example

Bart has a rental property with a loan of $100,000 owing. The interest is $3,000 pa and other costs are $3,000 but the income is $20,000. This means there is a taxable income of $14,000.

How will Bart be taxed on this?


If Bart has no other income in Australia, then his taxable income would be $14,000. There is no tax-free threshold for non-residents and the first rung of tax is 32.5% so Bart would pay tax on $14,000 x 32.5% or $4,550 per year.


Example 2

Bart’s sister, Lisa, also has a property in Australia which is negatively geared. She is getting $20,000 per year in rent, but the costs are $30,000.

This will mean Lisa has a taxable income of negative $10,000.

How will Lisa be taxed?

Because the income is less than $0 there will be no tax payable.

The loss will be carried forward to the following year each year, until there is a positive income which will be then offset by the loss.

If Lisa came back in 10 years, there could be a carried forward loss of about $70,000 or so (allowing for increasing rents and decreasing loan interest).

This could mean Lisa can work in Australia and earn $90,000 in the first year and pay no income tax as her income would be $90,000 - $70,000 = $20,000 which is under the tax-free threshold.


Example 3

Maggie the other sister of Bart has 2 properties in Australia with one being negative geared and one positive geared. Maggie also becomes a non-resident.


How would Maggie be taxed?

If one is positive $10,000 and one negative $20,000 her taxable income in Australia would be negative $10,000 and no tax would be payable.

If one was positive $20,000 and one negative $10,000 her taxable income in Australia would be $10,000 and she would pay $3,250 tax on this.

 

if the property was also the main residence at some point prior to leaving for overseas the main residence exemption doesnt apply so all those third element costs become so critical.

 

A tax return must be lodged each year to include Australian source income only, and property deductions. If the property is neg geared it will stop being neg geared and instead lead to a carry forward tax loss which accrues and rolls onwards. On eventual return (i have seen people come back after 15+ years) this loss can offset future income or the CGT on sale etc.

Refinancing may be problematic too. Consider this before departure plans are firm.

The CGT discount is not available for the days while non-resident.

Sale of property while non-resident means withholding exemption isnt available and as Mike says any prior exemptions can be lost. I strongly suggest anyone who plans to depart Austalian seek property focussed tax advice as part of the plans. Putting your house up for sale and it selling the day after departure could have fatal and VERY costly tax consequences. Renting it out means you need to know the rules so you dont trigger problems while out of the country.

 

I wonder, could it be better in some circumstances not to claim things against income to create an even larger loss, but to keep the expenses to be claimed as a cost base expense against CGT when sold. Possibly could for people who plan to return and earn low incomes.

 

In this case Bart should consider making a $14,000 contribution to super. Then this is taxed at 15% i.e. $2,100. Did this for several years myself. Check how the country you are a tax resident of handles this situation - in my case the depreciation allowed was much higher than in Australia so net result was no more to pay other than the 15% to Australia.

 

Bart could be unable to contribute to super if his sole super choice is a smsf. SMSFs cannot receive contributions for members who are non-resident. But a public offer fund is no problem other than preservation. Bart must also take care not to claim more of a deduction that his taxable income less offsets. I have severaloffshore former tax residents who plan to return who offset their taxable income each year.

When someone asks if its better to not claim deductions and use 3rd element costs the effect of CGT discounts must be considered. It can halve benefits of third element costs.

 

But a non-resident doesn't get the 50% CGT discount during the period of non-residency

 

Of course, IF they are continually non-resident. There can be some compliactions such as 8 May 2012 and periods when they return as a tax reident prior to sale and past periods of main resdience and so much more. These can be impacted. Its not as simple as 0% discount in many cases. I did three such calcs just last week and discussed another three properties impacted just yesterday.

Ironically very few people who owned property at 8 May 2012 know about the limits or benefits of the valuation rule and when it can and cant be used. And sadly I suspect many will also not consider the 6 months rule for a former home when they do return as resident THEN sell. It can bring a prior exempt period back to life and may also be imapcted by s118.192 requiring TWO valuations. When combined with the 8 May 2012 rule it can save tax. Then the strategy that is common is the catch up contribution benefit to offset the gain that could be taxed. Common to find those who were non-resident have unused caps.

Its a good example of full on tax planning. Very complex

 

Although not related to non-residents,

Thinking along the same logic -
A) Ie if a low income earner, earning say $15k in rental income (only income) and below the tax threshold and paying $0 tax, thinks there could be a potential $5k depreciation claim on the IP but doesn’t have a depreciation schedule.

There would be no point to chase the depreciation schedule and reduce $0 tax to $0 tax and then in future have to add back $5k in depreciation to the CGT cost base.

Therefore saving potential say 22.5% (45% x 50% discount) x $5k = $1,125 in future CGT if it’s a significant gain.


B) However, if the net rental income was $0 instead and the depreciation resulted in a income tax / taxable loss of $5k, the loss could be carried forward into future income years.

Ie 1 year later the low earner started working and earning in the $50k range, the depreciation and carried forward losses would save 32% x $5k = $1,600 in current deductions v the future $1,125 CGT add-back in A) above.


I may have missed something in this logic but I’m sure either @Terry_w @Paul@PAS or @Mike A will point out where I’ve gone wrong.

 

Not claiming depreciation doesnt work since its not a 3rd element cost. Third element costs are costs of ownership. Div 40/43 are statutory deductions, not costs of ownership. And add back etc still occurs whether you claim or not.

Then there is the general ATO view...copied below

The costs of owning an asset include:

• rates
• land taxes
• repairs
• insurance premiums
• any non-deductible interest on loans used to finance
  • the acquisition of a CGT asset
  • capital expenditure to increase an asset’s value.

​

These expenses can be included in the cost base only if they are not deductible. This would happen if, for example, they were incurred for vacant land.​

You cannot:​

• include costs for which you can claim an income tax deduction

If a cost cant be claimed due to expired amendment that counts. eg Arrears of land tax. But alas you cant decide not to claim deductions.

 

A entity ‘can deduct’ an amount for the purposes of a provision in Div 110 at a particular time if

- the terms of the relevant deduction provision have been satisfied in respect of the amount; and
- the deduction is not prevented by the expiry of amendment periods under s. 170 of the
ITAA 1936

PS LA 2006/1 (GA) says that a taxpayer cannot deduct an amount under Div 43 for construction expenditure in respect of an asset if the taxpayer:

1. does not (as a question of fact) have sufficient information to determine the amount and nature of the expenditure;
2. does not seek to deduct an amount in relation to the expenditure under Div 43 (or any other provision).

This means that in working out a capital gain or loss arising from a CGT event happening in relation to the asset, the taxpayer is not required to reduce the cost base of the asset by the amount that is not actually deducted under Div 43 in relation to the asset.