Private ruling: Rental property - capital works deduction
Published: September 2013
Ruling period: Year ended 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2012

Ruling: Q1: Will you be entitled to claim a capital works deduction for your rental property where it is rented or available for rent at market rate? | A1: Yes.

Relevant facts and circumstances: Taxpayer X owned a house in the course of carrying on a business. The house was held as trading stock. Taxpayer X and Taxpayer Y moved into the house, at which point the house ceased to be trading stock. In accordance with section 70-110 of the Income Tax Assessment Act 1997 (ITAA 1997) the house was deemed to have been sold to someone else at arm's length and then immediately acquired by Taxpayer X and Taxpayer Y. Income from the 'sale' of the house was recorded in Taxpayer X's tax return for the 2011-12 financial year. During the 2012-13 financial year the house was rented out to an unrelated party at market rates.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 43-10 | Income Tax Assessment Act 1997 Section 43-75 | Income Tax Assessment Act 1997 Section 70-110

Reasons for decision: Summary: Taxpayer X and Taxpayer Y are entitled to claim a capital works deduction for the property during the period it is rented or available for rent at a market rate. | Detailed Reasoning - Detailed reasoning: Division 43 of the ITAA 1997 allows a deduction for capital expenditure incurred in constructing capital works, including buildings and structural improvements. A capital works deduction is generally available if the capital works are used to earn assessable income during the financial year. Where the capital works are only used to earn assessable income for part of the financial year, the deduction must be apportioned. For a taxpayer to claim a capital works deduction, the capital works must have a construction expenditure area. Subsection 43-75(1) of the ITAA 1997 provides that the construction expenditure area of capital works that commenced after 30 June 1997 is that part of the capital works on which the construction expenditure was incurred that was to be owned or leased by the taxpayer at the time the construction expenditure occurred. This subsection essentially allows a deduction for only the taxpayer who incurred the construction expenditure. Subsection 43-75(3) of the ITAA 1997 addresses the situation where a taxpayer purchases a building from a speculative builder. A speculative builder constructing a building for sale incurs expenditure on revenue rather than capital account. Thus, there is no construction expenditure for the purposes of Division 43 of the ITAA 1997. Broadly stated, subsection 43-75(3) of the ITAA 1997 allows a deduction for a taxpayer who purchases capital works from an entity that: (a) is not an associate of the taxpayer, and (b) incurred expenditure in constructing the capital works on land it owned or leased in the course of a business that included the construction and sale of such works. | Detailed Reasoning - Application to this case: Taxpayer X owned a house which was treated as trading stock. The house was converted to a private use asset. Taxpayer X treated the conversion in accordance with section 70-110 of the ITAA 1997. Under that section Taxpayer X: · was deemed to have sold the house to someone else at arm's length, that is, in the same manner as if Taxpayer X had sold the property to an unrelated party in the course of carrying on Taxpayer X's business · the 'sale income' was declared in Taxpayer X's tax return as business income · Taxpayer X and Taxpayer Y are deemed to have acquired the property for the same amount as the 'sale price'. The effect of section 70-110 of the ITAA 1997 is to treat the conversion of the trading stock to private use as if the trading stock had been sold to an unrelated party and the taxpayer had acquired the same or a similar type of item from an unrelated party for their own use. In relation to subsection 43-75(3) of the ITAA 1997, section 70-110 of the ITAA 1997 deems Taxpayer X and Taxpayer Y to have acquired the house from an unrelated entity and, therefore, that entity would not be deemed an associate of Taxpayer X and Taxpayer Y. As Taxpayer X and Taxpayer Y are deemed to have acquired the house from an unrelated third party, they will be entitled to a capital works deduction in relation to the construction expenditure for the period the house is rented or available for rent at market rates.