Private ruling: Deductible expenses and accessibility of an insurance payment
Published: June 2013
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | The scheme commenced on: | 1 July 2010

Ruling: Questions and answers: | 1. Are you entitled to a deduction in full for bank interest, water rates, building and landlord insurance, management fees and council rates? | No. | 2. Are you entitled to a deduction in part for bank interest, water rates, building and landlord insurance, management fees and council rates? | Yes. | 3. Is the insurance payment for loss and destruction of your rental property assessable ordinary income? | No. | 4. Is the insurance payment for loss and destruction of your rental property assessable under the capital gains provisions? | Yes. | 5. Did the destruction of the property trigger CGT event C1? | Yes | 6. Are roll-over provisions applicable where a capital gain is realised as a result of CGT event C1? | Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997, Section 8-1. | Income Tax Assessment Act 1997, Section 6-5. | Income Tax Assessment Act 1997, Section 6-10. | Income Tax Assessment Act 1997, Section 124-75. | Income Tax Assessment Act 1997, Section 104-20. | Income Tax Assessment Act 1997, Section 102-20.

Reasons for decision: Detailed Reasoning - Deductibility of rental property expenses: 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. Expenses relating to a rental property are deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Bank interest, management fees, water rates and council rates: 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, considers deductions for interest incurred prior to the commencement of income earning activities and the implications of the decision of the High Court in Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 ( Steele's Case ). 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. 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 same principles can be applied to other types of expenditure including local council, water and sewage rates, land taxes and emergency services levies. In your case, the dwelling was situated on your property suffered extensive damage and was required to be rebuilt as a result of a natural disaster. The property was used in part as a rental property. You are in the process of re-building the dwelling with construction expected to be completed shortly. Once construction of the dwelling is complete it will be once again be used as a rental property. Applying the principles established in Steele's Case you are entitled to a deduction for bank interest, building and land lord insurance, management fees, water rates and council rates while the dwelling is under construction. However this does not extend to the period prior to the natural disaster, where you and your spouse occupied the upper level of the residence for private use. Therefore you will be required to apportion the expenses between the upper and lower level for this period. Accordingly, you are entitled to a deduction in part for bank interest, management fees, water rates and council rates under section 8-1 of the ITAA 1997. As you and your spouse are co-owners, you will be required to apportion the deductions according to your ownership interests. | Detailed Reasoning - Assessability of compensation payout: Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year. Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that: - are earned - are expected - are relied upon, and - have an element of periodicity, recurrence or regularity. In your case, you received an insurance payout specifically for the destruction of the dwelling situated on you property as a consequence of a natural disaster. Therefore the payment does not fit into the three categories of ordinary income listed above. It is a one-off payment without an element of recurrence or regularity and does not possess any of the other characteristics of ordinary income listed. Accordingly, the payment is not assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Capital gains provisions: Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision are called statutory income and are also included in assessable income. Section 102-20 of the ITAA 1997 provides that capital gains tax (CGT) is the tax you pay on certain gains that you make. Section 102-20 advises that you make a capital gain or capital loss as a result of a CGT event. Section 104-20 of the ITAA 1997 provides that capital gains tax (CGT) event C1 occurs if a CGT asset owned by a taxpayer is lost or destroyed. The time of the event is when compensation for the loss or destruction is first received. A capital gain is made if the compensation amount is more than the asset's cost base or a capital loss is made if the compensation amount is less than the asset's reduced cost base. In your case, a natural disaster extensively damaged the dwelling situated on your property. As consequence you received an insurance payout for the destruction caused. The destruction of the dwelling triggered a CGT event C1. The time of the CGT event was when you received your insurance payout. Accordingly, any capital gain or loss made as a result of CGT event C1 will be assessable under section 6-10 of the ITAA 1997. | Detailed Reasoning - Rollover relief: Section 124-70 of the ITAA 1997 may provide roll-over relief if an insurance payment is received for the loss or destruction of an asset. In the case of a post-CGT asset, the provisions allow deferment of any capital gain until such time as there is a disposal of the replacement asset. In your case the replacement asset will be the rental property which is under construction. However, section 124-75 of the ITAA 1997 provides that certain conditions must also be satisfied, for roll-over relief to be available, if an insurance payout is received. For section 124-75 of the ITAA 1997 to be satisfied a taxpayer must incur expenditure in acquiring another asset or repair or restore the original asset no later than one year after the end of the income year in which the money is received or until such time as the Commissioner allows in special circumstances. That replacement asset must be used for the same or similar purpose as the original asset, for example, if the original asset was used for rental purposes, then the new asset must also be used for rental purposes. If the replacement asset is not acquired, a capital gain or capital loss must be declared in the income year in which the insurance payment is received. In your case you owned a rental property in which the dwelling situated on the property was extensively damaged by natural disaster. You received an insurance payout for the destruction of the property. Within 12 months of receiving the insurance payout you have incurred construction expenses to re-build a replacement asset in the form of a dwelling. Once construction is complete, the property will once again be used to produce rental income. Accordingly, as conditions contained within section 124-75 of the ITAA 1997 have been satisfied, if a capital gain is realised as a result of CGT event C1, you will be entitled to defer the capital gain until such time that there is a disposal of your new rental property. | Detailed Reasoning - Further information: Please note that although you have requested this ruling to extend to 2019, due to changing nature of the tax law and the possibility of changes to the facts over time, the Commissioner will only provide a ruling for three years plus the current year.

Relevant facts: You and your spouse purchased a property. | The property that was purchased contained a dual occupancy dwelling which consisted of an upstairs and downstairs residence. | You and your spouse occupied the upstairs portion of the dwelling while the downstairs area was rented out to a tenant. | After a period you accepted an employment opportunity interstate. | In accepting the employment opportunity, your intention was to relocate interstate and rent the upstairs residence, in addition to the downstairs residence. | While you were in the process of moving interstate, a natural disaster occurred. | The natural disaster caused extensive damage to the residence. | As a result of the damage, the entire residence (both upstairs and downstairs) became uninhabitable which lead to the tenant that occupied the downstairs residence moving out of the property. | Since the event neither the top nor bottom residences have been leased, and therefore neither has earned any assessable income. | You have incurred the following general expenses in relation to the property pre and post the event; | You have received an insurance recoupment to cover the costs to rebuild the residence. | For the purpose of reconstructing the property you have enlisted the services of the following professionals: | In the process of engaging these professionals you have incurred expenses. These expenses were incurred within 12 months of receiving the insurance payout. | The residence is currently in construction phase and is expected to be completed within 2 years of the event. | Once construction is complete it will be made available for rent.