Private ruling: Rental property: interest expense deduction
Date of advice: 8 September 2017
Published: February 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled to a deduction for interest expenses incurred on borrowings to acquire land on which you intend to build a rental property? | A1: Yes

Relevant facts and circumstances: You purchased a block of land in late 201X. You purchased the land with the intention to build a rental property. You borrowed money from a bank to fund the purchase of the land. In mid-late 201X you entered into a contract with a builder to build the rental property. In mid 201Y the builder went into administration before development of the property began. You obtained quotes from a number of builders in late 201Y. In late 201Z you entered into a contract with a new builder. In late 201Z, before the building of the rental property was about to start, you were made redundant. As a result of the redundancy, you will not have the financial capability to borrow for the construction of the property until you find permanent or reliable employment. You have not ceased your contract with the builder. You have an agreement with the builders to put the contract on hold until you find permanent employment and are able to obtain finance. You will commence building as soon as you are able to secure finance.

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 to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature. Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income. Taxation Ruling TR 2004/4 considers deductions for interest incurred prior to the commencement of income earning activities. It states that expenditure can be deductible even if it is incurred in a period prior to the production of income. It discusses 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. In Steele’s case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. 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. TR 2004/4 states that, in considering the final of the above conditions, a test of 'continuing efforts' would need to be set within the context of the normal time frames of the relevant industry. However, if a venture becomes truly dormant and the holding of the asset is passive, relevant interest will not be deductible even if there is an intention to revive that venture sometime in the future. In your circumstances, you purchased land with the intention of building a rental property on it to produce assessable income. Since the land was purchased you have made continuous efforts to fulfil this intention. You currently have a contract with a builder and you have the intention and commitment to commence development of the rental property once you are able to obtain finance in the near future. Therefore you are entitled to claim a deduction for the interest expenses in the 2016-17 financial year. You will need to reassess in future years to determine if the venture has become dormant and your holding of the asset has become passive. This would include where the building contract is abandoned and/or you are unable to secure finance.