Private ruling: Rental property works
Date of advice: 30 October 2017
Published: March 2018
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled to a deduction for interest on your investment loan, strata levies and water rates prior to your property being rented? | A1: Yes

Relevant facts and circumstances: You purchased a property in November 2016 and your intention was always to use it for income producing purposes. It wasn’t rented in the 2017 income tax year. You were told that after certain renovations your rental return would be higher. As a result, prior to letting the property, you decided to carry out improvements. Before you could carry out the improvements, heavy and continuous rain caused water penetration damage to the interior of the property, preventing the planned renovations and delaying renting out of the property.

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. Expenses for which you may be entitled to claim an immediate deduction include: ● advertising for tenants ● body corporate fees and charges ● council rates ● water charges ● land tax ● cleaning ● gardening and lawn mowing ● pest control ● insurance (building, contents, public liability) ● interest expenses ● property agent’s fees and commission ● repairs and maintenance ● some legal expenses ● travel undertaken to inspect the property, to collect rent or for maintenance ● you can generally claim an immediate deduction (that is, against your current years income) for your expenses related to the management and maintenance of the property, including interest on loans. 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 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. Further, interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing. That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities. You can claim expenditure such as interest on loans, local council, water and sewage rates, land taxes and emergency services levy on land on which you have purchased to build a rental property or incurred during renovations to a property you intend to rent out. However, you cannot claim deductions from the time your intention changes, for example if you decide to use the property for private purposes. Under Taxation Ruling 2004/4, whereby interest may be claimed for a period prior to rent being received, the ATO accepts that interest incurred during 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 preliminary to the income-earning activities; ● The interest is not private or domestic; ● The period of interest outgoings before the derivation of assessable income is not so long that the necessary connection between the 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. This therefore means that, provided the ATO is satisfied that the above conditions have been met, a tax deduction for interest expenses incurred can be claimed before rental income is derived where, for example, the investment property is being constructed and/or undergoing construction for income-producing purposes. It is very important that the intention must always be and continues to exist for the generation of assessable income at all times, where the nexus between the interest expense incurred and the intention of deriving assessable income (rent) must not be broken, even though at the time there is no assessable income derived. In your case, you borrowed money to purchase an investment property. | Detailed Reasoning - Conclusion: As the deduction amounts for interest expense, strata levies and water rates are directly related to your rental property you are entitled to claim these as an immediate deduction.

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