With summer approaching and the market delivering opportunities for buyers, investors may well spend their holiday time contemplating the purchase of a bach in the location they choose to holiday in.

From a tax perspective, renting a bach throws up some specific issues to be aware of before buying.

Firstly, even though the bach will be rented night by night and will not be a “dwelling” it will still be subject to the interest limitation and bright-line rules. The fact that the bach is capable of being used as a dwelling trumps the fact that it is not being so used.

This means you do need to weigh up the new build opportunities against the already established bach when deciding what sort of property to buy.

That said, buying a section without covenants and relocating a building to it, will meet the definition of a new build.

MIXED-USE ASSET

The next issue is navigating the “mixed use asset rules”.

These rules were introduced to rein in large claims of tax losses where baches were made “available for rent” but in fact derived very little rental income relative to the expenses being claimed.

The mixed-use rules effectively serve to limit deductions where owners are not very serious about deriving rental income but leave some opportunities for those in the market for significant rental income from their baches by prioritising income over personal use.

A mixed-use asset is one that is used both privately and to derive income. Under the rules, rental income derived from renting the bach to the public must
be declared as income.

Expenditure that is specifically related to the income earning activity, like advertising charges for example, are 100 per cent deductible.

But expenditure that funds both private use and income generating use must be claimed subject to these formulae:

Expenditure x income earning days / income earning days + counted days

This formula essentially means mixed use expenditure can only be claimed relative to the number of days rented as a proportion of the total number of days the property is actually used.

So, if you rented your bach 50 nights and used it yourself 100 nights, your deductibility of mixed-use costs is 50/150 … 33 per cent.

This removes the previous opportunity to deduct expenditure when the property was available for rent, but vacant. The mixed-use asset rules also contain some quirky rules, for example, if close friends or family use the bach and pay less than a market value rent, the rent is excluded from income and the days they spend at the bach are considered private use.

‘So, if you rented your bach 50 nights and used it yourself 100 nights, your deductibility of mixed-use costs is 50/150 … 33 per cent’

RECORDING USE

Record keeping for these rules means tracking who uses the bach, whether they are relatives, and whether they are charged a full rental or just mates’ rates. There is also a specific loss ringfencing rule that ring-fences tax losses if the gross rental income from the bach does not exceed 2 per cent of the property’s CV.

There can also be GST issues associated with short-term letting. This activity is considered a taxable activity for GST rather than an exempt residential renting activity. This means that the owner will need to GST register for the taxable activity if the income derived from it exceeds $60,000. These rules, coupled with the brightline rules, mean that you need to think carefully about how to structure the bach purchase, especially if it’s not a new build.

Planning a structuring arrangement around planned rental use but then finding that over time you are using the property more personally and less for rental could mean that the structuring is no longer appropriate.

Changing the ownership within the bright-line period can be problematic.

Family attachments to baches can become very strong so the protections offered by trusts, and the opportunity for succession planning for next generations also need to be front of mind when considering bach ownership.