When an asset, such as a bach or a boat, is used both privately and to generate income, prescriptive rules exist within the Income Tax Act that determine the extent to which a tax deduction is available.
Expenses broadly fall into three categories: fully deductible, non-deductible and apportioned.
An expense is fully deductible if it is incurred solely to generate taxable income.
Non-deductible expenses arise directly from any private use of the asset.
Finally, apportioned expenses arise when an expense relates to both income-earning and private use of the asset, with a tax deduction available based on the number of days the asset is used to derive income, as a proportion of the total number of days the asset is used for either purpose.
Private use is defined as the owner’s personal or family use of the asset, and any other person who pays less than 80% of the market value for the use of the asset.
For example, if a bach is rented to your sister for full market rent and a friend for 70% of the market rent, both instances qualify as private use and the income is exempt from tax. Similarly, expenses incurred relating to this use of the asset are non-deductible.
Keeping a bach in mind, an example of a fully deductible expense would be advertising costs. Conversely, if the owner of the bach purchased a kayak that was unavailable for tenant’s use, the cost would be non-deductible. While general holding costs such as rates, general repairs and insurance are apportioned based on the proportion of days the asset is used to derive income.
If a net loss arises from the asset, that loss is typically ring-fenced and cannot be offset against other income. Instead, the loss must be transferred forward and offset against future profits from the asset.
In addition to Income Tax, there are separate GST rules that apply to mixed-used assets. GST recovery is broadly based on the anticipated split of private / income use. However, unlike the income tax rules summarised above, GST can be recovered on use by the owners and their family, providing market value is paid for use of the asset. Hence, different recovery percentages can arise between income tax versus GST.
Before you consider putting the bach up for rent, it is worth checking whether the mixed use asset rules will apply and what records you need to keep to ensure you can apply the rules correctly.