When do residential rental activities amount to a business? A recent ruling shows owning as few as five residential rental properties will change your tax status significantly

When do residential rental activities amount to a business? A recent ruling shows owning as few as five residential rental properties will change your tax status significantly

By Lindsay Ng*

[This article was first published in The Journal, an NZICA publication. It is used here with permission.]

Inland Revenue (IR) has had a win in the Taxation Review Authority (TRA) where it was held that the ownership of five residential rental properties amounted to the carrying on of a business.

As a result the rental losses derived, which had been included by the taxpayer in calculating her entitlement to Working for Families tax credits (WfF), were disallowed.

The facts

The facts in TRA 012/11 are summarised below.

• The taxpayer is a self-employed artist who is married with five children. She registered for WfF in April 1999.

• In the course of a tax investigation IR discovered that the taxpayer owned five residential rental properties in partnership with her husband.

• The properties were purchased between April 2003 and September 2007 with small deposit amounts.

• The taxpayer engaged a property manager to manage the five rental properties in December 2007.

• An accountant was engaged to prepare rental accounts and tax returns.

The key issue to be determined in the TRA was whether or not the residential rental activities amounted to a “business” as defined in section OB 1 of the Income Tax Act 2004. This is because, under the WfF rules applicable to this case, losses incurred from investment activities could be taken into account for WfF purposes but business losses could not.1

Generally whether or not activities carried on by a taxpayer amount to a “business” involves consideration of whether or not there was an undertaking carried on for pecuniary profit. The term “pecuniary profit” is not legislatively defined; however, its meaning has been considered in case law.

Commissioner’s arguments

The Commissioner argued as follows.

• The taxpayer’s residential rental activities amounted to a business. This conclusion is drawn from:

- the overall nature of the rental operation

- the nature and scale of the operation

- the investment of time, money and effort

- the real and potential profit derived.

• “Pecuniary profit” cannot be equated with a profit for tax assessment purposes.

• The taxpayer’s asserted intention that the rental properties were held for long-term capital gains needed to be assessed against objective factors. These factors (above) supported the conclusion a business was being carried on.

• In this case the WfF rules were exploited and this factor is also relevant when establishing whether or not the taxpayer intended to make a “pecuniary profit”.

Taxpayer’s arguments

The taxpayer argued that despite accepting a rental property operation involving the number of properties in this case can amount to a business, there was no business for the following reasons

• It was understood the level of mortgages on each property and the running and maintenance costs of each property would mean losses would be made; therefore, there was no prospect of a revenue profit.

• The investment properties were purchased to give her children an investment that has grown in value (that is, a capital gain); therefore, there was no intention to make a “pecuniary profit”.

• “Pecuniary profit” does not include a capital gain, it being capital and not revenue in nature.

• The desire to make capital gains cannot convert an activity into a business.

• The taxpayer’s activities were inconsistent with a business pattern and she sought to increase her wealth by capital gain and not by earnings.


The TRA agreed with the IR. In reaching this decision the following factors were considered:

• Nature of the activity – conceded by the taxpayer to be able to amount to a business and held to be so in this case. Also the taxpayer’s activity encompassed operating a structure to seek capital profits.

• Period over which activity is engaged – five rental properties acquired in a two-year period with no indication the operation will be terminated.

• Scale of operation and volume of transactions – management of maintenance, mortgage payments and tenancy agreements on five or six properties; capital value of rental properties exceeded $750,000 (a sizeable financial commitment for a person with income of less than $60,000); reliance on rental payments and WfF to service the mortgages.

• Commitment of time, money and effort – financial commitment was significant and need for use of property manager relevant.

• Pattern of activity – WfF entitlements increased dramatically during the time three to four rental properties were purchased. The pattern of activity and the taxpayer’s own evidence showed the incentive of higher WfF payments was a key motivating factor for the structure of the activity.

• The financial results – assessable rental income was derived, rental losses were used to increase WfF entitlements, and there was potential for long-term capital or equity gains. Each of these indicated an increase in the taxpayer’s wealth by profit in money’s worth.

• The taxpayer’s intention – capital profit is pecuniary profit in the context of this case. The taxpayer had an intention to profit from the rental activities.

• Type of profit – the meaning of “pecuniary profit” is not restricted to a taxable profit.

Further, the TRA stated, through the scale and structure of the rental operation, undertaken in view of the WfF payments available where income is reduced by losses, the taxpayer has obtained money or money’s worth. Overall, the taxpayer’s activity is geared with an intention for pecuniary profit.

Food for thought

The TRA decision raises a number of practical issues.

Relationship between pecuniary profit and non-taxable capital profit

The TRA decision suggests pecuniary profit includes capital profit that is not otherwise assessable under the Income Tax Act 2007 (ITA07). This conclusion is not consistent with the scheme and purpose of the taxing provisions in the ITA07 where, unless otherwise provided, tax is payable on receipts of income, not capital.

Further, the purpose of the business test is to determine a point in time in which a person’s activities are to be brought to tax.

Such an interpretation appears to extend the principles established by the Court of Appeal in Grieve v CIR (1984) 6 NZTC 61,682 and CIR v Stockwell (1992) 14 NZTC 9,190. In Grieve Richardson J in the Court of Appeal stated that the crucial factors are the character and circumstances of the particular venture. In Stockwell Cooke P in the Court of Appeal stated that in a grey area case he would lean against a finding of a business2.

It would seem a step too far to suggest that the business test equates “pecuniary profit” (taxable) with “capital profit” (non-taxable). Whether or not a person is carrying on a business is very much a question of fact in each case.

Dividing line between “investment activities” and “business activities”

Under a self-assessment system a taxpayer must determine their income tax liability. The decision in TRA 012/11 raises the question of what criteria would be hallmarks of an investment activity or a business activity. At what point would an investment activity cross the line to become a business activity?

Coincidentally IR published a statement in Tax Information Bulletin Vol 6, No 3 (September 1994) in the context of WfF:

“For income tax purposes, rental losses are deductible in full. However, a person cannot be said to be in the ‘business of renting’ unless there is an intention of making a profit from the rental activities. Often, the mere holding of property to derive rental income does not constitute a business.
Factors to be considered in determining whether a taxpayer is ‘in the business of renting’, or if the rental activity is of a non-business nature include:

• the scale of the operation and the volume of transactions. A taxpayer who owns several rental properties is more likely to be ‘in the business of renting’ than a person with only one property.

• the commitment of time, money and effort. Comparing these with operations normally involved with an operation that has been determined as a ‘rental business’.

• the pattern of activity and the financial results. A profit is not likely to be as important to a person acquiring a property for investment purposes; for example the rental income is used to offset the costs of owning the property, such as rates, insurance etc.

Example 1
A taxpayer borrows a substantial amount of money, and uses it to buy a house for investment as part of a retirement plan. The house is rented at a market rental, but the interest exceeds the rental income earned. The rental loss is deductible for Family Support purposes.

The taxpayer is not in the business of renting because the property has been acquired as part of a retirement investment plan, and the commitment of time and effort in collecting the rent, maintaining the property etc is less than would normally be involved in a ‘rental business’.

Example 2
A taxpayer owned two houses and a block of five flats. She collected the rents, interviewed tenants, and did some of the maintenance and repair work. The Taxation Review Authority in Case F111 (1984) 6 NZTC 60,094 held that the taxpayer was carrying on the business of a landlord.

The rental loss is not deductible. For Family Support purposes the loss is treated as nil.

It cannot be assumed that a rental activity conducted by a taxpayer is a business. Before that can be determined, the nature of the rental activity needs to be considered.”

We understand this statement still represents the view of IR. Further IR guidance or public comment would be helpful for taxpayers in assessing this difficult issue.


In our view the application by the TRA in Case 012/11 of the factors used to determine whether or not there was a “business” is highly influenced by the underlying policy of the WfF regime3. This element should not be overlooked in considering the general application of the decision.


1. From the 2011-12 income year investment losses are no longer taken into account for WfF purposes.

2. “When a taxpayer has a full-time occupation and devotes some of his spare time to stock exchange speculation, one should be slow, I think, to find that he has gone as far as to embark on a business. Usually it would be an artificial use of language. The same applies to a retired or unemployed person who engages in a modest amount of buying and selling shares. In such cases the presumption should be against a business.”

3. The policy being to support families with dependent children, to ensure income adequacy for low and middle income families with dependent children, and to achieve a social assistance system that supports people into work.


Lindsay Ng, is the Tax Manager at the accounting professional boby NZICA in Wellington. This article was first published here »  and is used with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.


This is a good example of the transfer of the rule of law to the rule of lawyers.The underlying embedded disease behind the problem,
This was used (quite convincingly ) by Niall Ferguson in the Reith Lectures.
The same problems that are the destabalizing influences in the financial market regulations,are the same problems in taxation regulation.EG
Is financial regulation the disease of which it purports to be the cure, asks economic historian Prof Niall Ferguson in his second Reith Lecture. He argues that overly complex financial regulation is to blame for the 2007 financial crisis - not deregulation, as many others claim. The solution to getting the banks to behave, he says, is not more regulation but scaled back, simplified regulation and, importantly, full enforcement of the law.
Paul Volcker was agressive in the over complification of the Dodds Frank bill,which extended to over 1200 pages in its final draft,and  which no one understands what it means.The ambiguous nature of these tomes in the Library of Babel does not decrease uncertainty it increases it .
reduction is the evolutionary paradigm, evolve you dinosaurs.

Poisson - thanks for posting those links. Haven't listened to all of Niall Ferguson's lectures  as yet. He makes some very good points.

I can vouch for the Niall Ferguson Reith Lectures .... totally brilliant .

This is an excellent decision from the TRA. Too many people have rorted WFF and University allowances up to now. Just ask anyone at university in NZ. The children of farmers and alike were getting allowances as a result of their parents taxation minimalisation activiities. It is amazing how selfish people can be when the opportunity presents itself. How is this country supposed to be getting out of its financial difficulties when so many people are trying to avoid paying their way.

I don't think it's selfish - it's rational. The govt is offering free money, people are merely taking the opportunity. Hence the reasoning behind a universal child allowance, rather than relying on an income based approach.
But agree this case provides the right outcome. Of course owning rental properties is a business. Surely as soon as you start deducting your property expenses against your rental income you're in business? All property owners are running rentals as a business, it's not a hobby!

Their argument:
“Pecuniary profit” does not include a capital gain, it being capital and not revenue in nature.
The desire to make capital gains cannot convert an activity into a business.
The taxpayer’s activities were inconsistent with a business pattern and she sought to increase her wealth by capital gain and not by earnings."
Our bizarre concept that a capital gain is irrelevant to business & to tax considerations is unique in the developed world, & leads to the most staggering distortions, as shown here. 
It is crazy and really needs to be knocked on the head before we descend to third world economic levels
Go the IRD! But it would be nice if the Govt was behind them.

Philly I think you will find the govt is behind them. Refer to ref note 1 above. 
With respect to wff and student allowance (now also governed under the Family Scheme Income rules as used for wff) most of the loopholes are technically closed.  The new rules are designed to test economic income (such as trust & company earnings) as opposed to strictly taxable income.

OK, fair enough. 
To be honest, one rental is a business - what else is it?  A hobby? 
If it is purely to gain a tax-free capital gain, then you shouldn't be able to claim a tax deduction on the costs ie interest payments.  If you claim costs, then the gains should be taxed.  It is as simple as that. 

Ok. For the dimmer amongst us (for example, myself). What are the implications for the person concerned in terms of having their activities defined as a business?

I was thinking the same thing, ive a friend with multiple houses and when it looks like hes getting close to making some money, he rushes out to buy and gear up another property, which is happening this week. He has made no money and paid no tax for years as he writes his income off against his losses.
 On the other hand i personally pay a ton of tax and need to somehow reduce my exposure, i just lack the balls to pile into housing, my accountant is the most honest SOB on the planet, used to piss me off till the accountant down the road scaffed off with 21 mill. He now lives in a nice house in Taupo with a nice BMW after 3 years in jail, they couldn't touch his trusts. My accountant always wondered how a small town accountant can make one mill a year out of 30 clients with out being a bit dodgy.
 The government needs more money so I guess they need to bring more people into the net.

Andrewj - your last sentence pretty much sums it up. In this particular case it appears that if the couple had structured themselves differently the outcome would be different.
The more the rules change, the more complex a system becomes, the more creative business people have to become.  This particular case will have some interesting outcomes for a lot of people.

Andrewj your friend might not be doing as well as he makes out. If you are paying tax you are making money. Remember he is only getting back from IRD a maximum of 33 cents in the dollar. If he pays a $1 in interest to the bank he only gets back 33 cents and he actually loses the other 67cents which he never sees again. He then needs to achieve capital gains every year to get back the 67 cents that has disappeared down a big black hole never to be seen again and he needs to covers inflation also every year.  Where does he own his rentals.If he is not in Auckland then he is going backwards generally.  Negative gearing only makes sense in a rising market. In a dropping market you are going backwards from both a cash flow and capital  basis. From my experience a lot of landlords did not understand negative gearing when they got into investing and some of them never tell you the truth. A lot of them are propping up their investments from their salaries and wages. Paying tax means you are getting somewhere. Negative gearing generally means you are going backwards and it needs propping up from other income sources and/or capital gain.

He diversified into California, and purchased houses with no debt by selling in NZ taking the capital gain and investing over here. He now has less than half his investment in NZ.
 Now all the bottom end around here has been sold to large corporates, no one knows who but someone took Buffets advice and grapped all the houses between 100-150k. They rent for $1100 a month so you can see the attraction if you are used to getting % 0.2 on deposit at the bank. 
 Need to start up a property management firm although rumor is they are starting their own, must have been a tonne of houses sold in the past 3 months in the lower price bracket in California, the problem is the banks are still sitting on a zillion empty houses they dont want to mark to market. Oh, and the State is really very very broke, although they think they have enough for a high speed rail link..

Good points ex Agent.
I recently showed some property owners negatively geared that thye were effectively paying $200 per week for the pleasure of their tenents to live in their rental property. (int + rates + ins = $500 against $300 rent)
Sell the rental and be better off by $200 per week or better still applly that $200 as extra pyments towards their mortgage on own home and be debt free in under 10 years, somethng they won't achieve by holding onto toi their rental.

MIST: "exposes you to lazy tenants who have to be cleaned up after, who wreck stuff and don't think they should pay for damages, super-lazy "property managers"
Reading the articles and columns and comments on these pages for 3 years one would believe property investing is a breeze, producing untold wealth and riches for the timid. There for the taking.
Congratulations. You are the first I have seen comment on the downside, the pain, disillusionment, destruction and LOSSES that occur, all too frequently. It aint all a bed of roses, and it aint all pretty.

but think of the tax free capital gains... Property investors can't have it ALL their own way!

Look NZ needs property people to buy an do up old houses for renting.
NZ can not give everybody a statehouse
There is very affordable housing in NZ,just not in the blue chip areas
Look at the cost off the social welfare an statehousing
Tax the property people more an they will invest off shore,NZ property people are getting great returns in the US.
Its better to keep property people investing in this country.
Property people spend money which gives people real work.
The country needs real jobs an work now.,free some money up an let the property investors
get this country back on track.
NZ needs everybody back working again

Comments like these really wish interest.co.nz had a downvote button...

Yep, so astoundingly stupid it is hard to put words to it. Regards.

Walter Kunz did lobby Bernard to introduce a down-vote button , 'cos some spazmo blogger was getting on his Swiss tits ( ....... ahem ! ) .....
....... but Bernie's too busy these days , got more interest in his new career .....
Sorry !

NZ property people are getting great returns in the US.
The US has property tax,and CGT.for non residents when you sell,the escrow company holds 10% of the sale price as federal withholding tax.
Some states also implement a state WHT for non residents eg Hawaii has an additional 5% this makes property a  rather illiquid equity for non residents.

Yes they are getting great returns in many cases. What you state is only the case if you do not structure it right:-)

Why 5 rental properties and not say  2 or 3 or 4 or 6?  How did the pointy heads arrive at the figure 5?