Private ruling: Interest deductibility
Date of advice: 19 September 2017
Published: February 2018
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Q1: Is the interest incurred on a loan taken out to purchase land and construct a house deductible, in whole or in part, after the property was sold at a loss? | A1: No

Relevant facts and circumstances: In 20AA split loans were taken out for the purchase of land and construction of a house. The total loan amount was $XXX with $XXX secured against a family member’s property. Late 20BB construction of the house was completed. On completion of construction the house you moved into it. Due to the cost of overruns and financial pressure the property was placed on the market for sale with a real estate agent as soon as the building construction phase was complete. In late 20BB you decided to rent the property on completion of works due to a lack of interest in sale. In early 20CC you completed external works (fencing, lawn, pool, etc.) you vacated the property and placed the property for rent with a different real estate agent. When you made the decision to place the property up for rent you took it off the market for sale. From mid 20CC the property was available for rent. On or around 20CC you were approached by the original real estate agent, whom you had used to try to sell your house, to ask if you still wanted to sell your property as they had a prospective buyer. In Late 20CC a contract for sale was accepted for $XXX. The loans secured over the property was paid out leaving approximately $XXX, which was the loan secured over the family members property. Just prior to accepting the contract for sale you had arranged for a tenant to occupy the property. You had to cancel this tenancy agreement as the purchaser wished to occupy the property at your expense.

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, or necessarily incurred in carrying on a business for the purpose of 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. Taxation Ruling TR 2004/4 discusses the issue of deductions for interest incurred prior to the commencement of, or following the cessation of relevant income earning activities. Paragraph 10 of TR 2004/4 states that where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and the relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing the assessable income if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period. Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgement about the nexus between the outgoing and the income earning activities. In Placer Pacific Management Pty Limited v. FCT (1995) 31 ATR 253; 95 ATC 4459, the full Federal Court held that an expense will not cease to be deductible simply because the assessable income was earned in a year prior to the incurring of the expense. Therefore, the interest expense will be deductible under section 8-1 of the ITAA 1997 if there is a sufficient nexus or connection between the incurring of the interest expense and the assessable income that was produced by the asset that was originally purchased with the borrowed funds. We acknowledge that a loss or outgoing may be deductible even if it is incurred after the cessation of income earning activities, but in order to be deductible the occasion of the outgoing must be found in those income earning activities. In your case, the original occasion, or purpose, of the split loans was to purchase land and construct your main residence. Upon completion of construction you realised the costs and financial pressures were too much and placed the property on the market for sale. After not being able to find a willing buyer you made the decision to take it off the market and rent it. You were then approached by the original real estate agent and subsequently sold your home without producing assessable income from it being a rental for approximately X months. Essentially there was no income earned. After considering the above facts, the case mentioned above can be distinguished from your situation, in that at the time your borrowing was taken out there was not a sufficient nexus or connection between your assessable income and the interest incurred on the borrowing. This is because the borrowed funds were private in nature. While you did make the property available for rent, the short amount of time it was available and that it did not produce any assessable income means that for that period there was only a mere expectation of income. This was not enough to sever the connection to the original purpose of the loan when the property was sold, at that point the nature of the loan reverted back to its original purpose. Having regard to all your circumstances, it is considered that your loan is largely private in nature and therefore no deduction is allowable under section 8-1 of the ITAA 1997.