Private ruling: Property expenses
Date of advice: 11 January 2017
Published: June 2017
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to a deduction for interest expenses and rates incurred in relation to your property until a specific month in 20XX? | A1: Yes. | Q2: Are you entitled to a deduction for interest expenses and rates incurred in relation to your property after a specific month in 20XX? | A2: No. | Q3: Are you entitled to a deduction for the lost deposit? | A3: No. | Q4: Is there a capital loss made on the lost deposit under the capital gains tax provisions? | A4: Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1. | Income Tax Assessment Act 1997 Section 104-25. | Income Tax Assessment Act 1997 Section 108-5.

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, or relate to the earning of exempt income. Generally, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances. Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith 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, regard must be given to all the circumstances including 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. The Commissioner's view on whether interest deductions are allowable 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 ) are outlined in Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities. In Steeles 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. While Steele's case deals with the issue of interest, the principles can be applied to other types of holding expenditure such as rates. 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. Interest deductions in relation to the purchase of a block of land were also discussed in Temelli v. FC of T 97 ATC 4716; (1997) 36 ATR 417 ( Temellis case ). In this case it was found that there was not a sufficient connection between the interest paid and the prospective income producing activity for a deduction to be allowed. In Temellis case the taxpayers purchased a block of land with the intention of building a house for rental purposes. Three years later, they had not proceeded beyond having drawings and cost estimates prepared. In distinguishing the matter from the earlier decision of the Full Federal Court in Steele v. FC of T 97 ATC 4239 (Steele), the Court noted at 4243 that Steele had demonstrated the required commitment to the redevelopment of grazing land into a motel and townhouse complex. After purchasing the land, Steele had in fact obtained Councils assent to a zoning change, employed architects and engineers, entered into a joint venture arrangement and pursued the project with some tenacity until litigation with her collaborator put a complete stop to it. She demonstrated her commitment from the beginning by putting $1 million into the venture plus the time, energy and considerable expense of the subsequent architectural and engineering work and negotiations with the local council, sewerage authority and prospective joint venturers and financiers. The level of commitment demonstrated by Steele to the project was not an issue in the appeal to the High Court. In Temellis case the Court found that the taxpayers had not made a decision to proceed with the building of a house on the land for a number of years. Their lack of commitment to the project lead to the conclusion that the associated expenses were not an allowable deduction. It was found that the temporal gap left open the possibility of a non-income producing purpose to such an extent that the required nexus did not exist. Following the guidelines in TR 2004/4, you are entitled to claim a deduction for the interest expenses and rates from the purchase of your land to March 2015 when the building was put on hold. However after this date, as the building has been postponed, it cannot be said that continuing efforts to complete the building are being made. We acknowledge that the downturn and associated circumstances were beyond your control and your intention in purchasing the land was to have an income producing property. However, as the project has now been put on hold, the necessary connection between the interest and rates and assessable income is lost. Accordingly, you are not entitled to a deduction for the interest expenditure or rates you incurred in relation to your vacant land after 20XX. Capital gains tax provisions Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens. The gain or loss is made at the time of the CGT event. Section 108-5 of the ITAA 1997 states that a CGT asset is any kind of property, or a legal or equitable right that is not property. As a result of you entering into the arrangement with the builder, it is considered that you acquired contractual rights. These contractual rights are CGT assets. Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being abandoned, surrendered or forfeited or being released, discharged or satisfied. The time of a CGT event C2 is when you enter into the contract that results in the asset ending (for example, a settlement deed) or, if there is no contract, when the asset ends. You make a capital loss from CGT event C2 happening if your capital proceeds from the event are less than the asset's reduced cost base. In your case you paid a deposit to the builder. As the building did not proceed and you lost your deposit, a CGT C2 event occurred. A net capital loss is not deductible from your assessable income. However, it can be offset against capital gains made in later income years. To the extent that a net capital loss cannot be used to offset capital gains in an income year, it can be carried forward to a later income year. In your case, your C2 capital loss occurred in the 20XX-YY financial year. Please note that the capital loss as well as the allowable deductions are shared equally between you and your spouse according to your legal title in the property.

Relevant facts: You and your spouse purchased land with the intention of building a house, to commence following settlement. | You paid a deposit to the builder and a Master Builders contract was completed with the builder. The building of the house was approved by the local council. | The intention was then to rent the house. | There was then a major downturn in the area and there was an oversupply of property in the area. Vacancies still remain high. | You postponed building the house in 20XX due to the future tenant advising they no longer required the house. | If the market improves, you may still build. | You jointly borrowed funds for the purchase of the land. | You have incurred interest expenses and rates for the property.