‘Passive’ property opportunities
Most tax practitioners would be aware that commercial property
that only produces passive income in the form of rent will not
qualify for small business CGT relief. Few practitioners would be
aware, however, that the property may qualify if additional services
and facilities are provided to the user and the user does not have
exclusive possession of the property.
A passive problem
For the small business CGT concessions to apply, a property must
be an ‘active’ asset (i.e. an asset used in the course of
carrying on a business). However, a property will be excluded from
being an ‘active’ asset if its main use is to derive rent,
unless derivation of rent is temporary (per section 152-40(4)(e) of
the Income Tax Assessment Act 1997). The property is excluded
even if it is used in carrying on a business. This situation is
illustrated in Taxation Determination TD 2006/78.
For example, Com Rent Pty Ltd (Com Rent) owns several commercial
rental properties. Each of these properties is subject to formal
lease agreements with commercial tenants. Com Rent manages the
leasing and provides its tenants with exclusive possession of the
properties. TD 2006/78 states that the main use of these properties
is to derive rent and accordingly they are excluded from being
‘active’ assets. The implication is that CGT relief is not
available when the commercial properties are sold.
‘Active’ property
The key factor in determining whether a property is being rented
is whether the occupier of the property has the right to exclusive
possession.
If the property is being leased under a lease agreement granting
exclusive possession, the payments are likely to be rent and the
property will not be ‘active’. However, if the arrangement
allows the person only to enter and use the property for certain
purposes and does not amount to a lease granting exclusive
possession, the payment is not likely to be rent in the technical
legal sense. In this case a landlord/ tenant relationship does not
exist and the owner maintains possession of the property.
Accordingly, the main use in carrying on business is not to derive
rental income, but generally some other type of income.
For example, Store-It Pty Ltd (Store-It) carries on a business of
providing storage space for domestic and commercial storage for
periods of one week to several years. Store-It provides 24-hour
security and cleaning services. The company also provides trailers,
trucks, trolleys, and boxes for sale or hire.
Store-It enters into a storage agreement with the storage users
for the right to enter and use the storage facilities. The users do
not have the right of exclusive possession of the facilities.
Therefore, the storage facilities are ‘active’ assets for the
purposes of the small business CGT rules.
Mixed-use property
The following factors need to be considered to determine whether
a property that is used partly for business and partly to derive
rent is an ‘active’ asset:
- the comparative areas of use of
the property (between deriving rent and other uses);
- the comparative times of use
(between deriving rent and other uses); and
- the comparative levels of income
derived from the different uses of the property.
Consider the following example — Bill uses 45% of his shop to
run a café and he lets the other 55% of the shop to a bakery. The
part of the shop that is leased consumes more of the land area but
the income derived from the café business is 85% of Bill’s total
income. As most of Bill’s income is derived from the café
business, the property is not excluded from being characterised as
an ‘active’ asset.
Tax practitioners should be aware that not all commercial
properties sold are ineligible for CGT relief. Practitioners should
ask their clients appropriate questions about the property and
investigate whether a landlord/tenant relationship, or some other
relationship, exists. Common examples of property that might qualify
for the concessions include motels, caravan parks, backpacker
hostels, and ‘bed and breakfast’ lodges.
This article appeared in Thomson’s InTax (May 2007); Australia’s best
independent monthly tax magazine. It provides concise reports of the
latest tax news, plus the practical implications of tax developments
in an easy-to-read magazine format. To find out more, phone Thomson
Customer Service on 1300 304 197 or click here.
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