Private ruling: Deduction - interest on loan - vacant land
Ruling period: Year ended 30 June 2010 | Year ending 30 June 2011 | Year ending 30 June 2012
Date scheme commenced: 1 June 2009

Ruling: Question and answer | Are you entitled to a deduction for interest on the loan monies used to purchase vacant land on which you will construct your private residence which will be partially leased to tenants? | Yes

Relevant facts and circumstances: You purchased a block of land. Settlement of the purchase occurred during 2010. Settlement of the construction contract occurred during 2011. Construction of the dwelling will commence during 2011. Construction is expected to be finished by the end of 2011. During the time since settlement of the purchase, you explored a number of builders, continued to save money, arranged for finance and investigated council requirements. You will reside in the property when it is built while at the same time, you will lease all other bedrooms to tenants. You will use the master bedroom, including the en-suite bathroom, as your own private area. All other bedrooms and the main bathroom, which includes the shower, bath and toilet, are to be used exclusively by the tenants. All common areas such as the living room, kitchen and laundry are to be commonly shared between you and the tenants. The garage and the driveway to the garage and walkway to the house are also to be mutually shared between you and the tenants. The area surrounding the house is accessible to both you and the tenants and is to be mutually shared. The tenants have the right to use the area for recreation functions, including BBQ, small scale gardening and also use of the clothesline. You will charge a commercial rate of rent to the tenants when the house is built.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent that they are incurred in gaining or producing your assessable income. However, no deduction is allowed to the extent that the loss or outgoing is capital, private or domestic in nature, or related to the earning of exempt income. Taxation Ruling TR 2004/4 considers deductions for interest expenses incurred prior to the commencement of income earning activities and the implications of the decision of the High Court in Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 ( Steele's case ) as well as the decisions in the Full Federal Court . In Steele's case , the High Court found that the interest was incurred on borrowed funds that were used to acquire a property that was solely intended to be used in income earning operations and that Mrs Steele's intentions were always entirely commercial ones for the purpose of gaining or producing assessable income. There was no suggestion that the applicant ever contemplated using the property for private or domestic purposes. It was considered that the interest expense was not preliminary or incurred at a point 'too soon' before the commencement of the income producing activity. TR 2004/4 concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances: · the interest is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities, · the interest is not private or domestic, · the period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost, · the interest is incurred with one end in view, the gaining or producing of assessable income, and · continuing efforts are undertaken in pursuit of that end. In your case, the interest is incurred on borrowed funds used to acquire vacant land on which you will construct a residence which is intended to be used for both private and income earning purposes. In these circumstances, the interest expense is not considered to have been preliminary or incurred at a point 'too soon' before the commencement of the income producing activity. Furthermore, you have shown commitment to the project by taking steps prior to construction by saving money, consulting various builders, choosing most appropriate floor plan and investigating council requirements. The length of time between purchase of the property and commencement of construction is not considered to be so long that the necessary connection between the interest outgoings and the assessable income is lost. Accordingly, you are entitled to a deduction for the interest expense under section 8-1 of the ITAA 1997, but only to the extent that it will be incurred in earning your assessable rental income.

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