“Arms-length” rental for son

Question from Neill updated on 6th August 2014:

We have a four-bedroom townhouse rental in Auckland we have owned for over a decade in a look through company. Our son will be studying at the University of Auckland for the next four years and it would be an ideal place for him to stay with some flatmates. How can we do this without getting on the wrong side of the Inland Revenue Department or triggering depreciation recovery? The property makes a healthy surplus at market rental and three flatmates would easily cover the outgoings so could it be a tax effective way for us to help him minimise his student loan. Regards, Neill

Our expert Mark Withers responded:

Dear Neill, Where the tenant is a related party to the owners of the property, it is essential that the rent be set on an arms-length basis. An independent rent assessment should be obtained by a company director for the property and rent should be set at that level. If you discount the rent because he is your son you are essentially turning the matter into a private and domestic arrangement and this would call into question other deductions for the property. My view would be that your son should sign the tenancy agreement but that you consent to him sub letting the property to flatmates. It will be problematic if the company has to collect individual rent payments from each flatmate and your son. Your son will then potentially need to consider his own tax position relative to the rent he is collecting from his flatmates verses what he is paying the company for the tenancy. If he derives a profit this may be taxable to him. Quite honestly, it may be more sensible for him to rent elsewhere so that you avoid clouding the company’s affairs with the related party rent arrangement. It’s also a recipe for family trouble if the conduct of the tenancy and the subletting to the flatmates leaves your son responsible to you for the conduct of his flatmates. Ask yourself whether you would ever be willing to exercise your rights under the Residential Tenancies Act given your son is the tenant. Many a wise man has cautioned against mixing family and friends with business.

Mark Withers and his team at Withers Tsang & Co specialise in advising on property related transactions, valuation and restructure services and tax planning.

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