Private ruling: Rental expenses
Published: November 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to a deduction for your share of the portion of the holding costs on the property that relate to the studio/granny flat which will be constructed then rented out at commercial rates? | A1: Yes.

Relevant facts and circumstances: You and your spouse purchased a residential property. The property is currently vacant land. You intend to build a new home and have engaged a building company. You intend to live in the new home when complete. Your new home will have a studio/granny flat with its own bathroom and kitchenette which you intend to rent out. The studio/granny flat will be rented at the commercial rate of rent.

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, or relate to the earning of exempt income. Generally, expenses incurred relating to a rental property are deductible under section 8-1 of the ITAA 1997 if the property is rented or available for rent in the income year in which you claim the deduction. Taxation Ruling TR 2004/4 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. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 ( Steele's Case ). While Steele's Case deals with the issue of interest, the principles can be applied to other types of holding expenditure. 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. It follows from Steele's Case that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income if: • 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. Where a property is used partly for income production purposes, apportionment of the expenses incurred in respect of that property may be required. As a general approach, apportionment should be made on a floor area basis, that is, by reference to the floor area of the residence to which the tenant lodger has sole occupancy. The floor area used to produce income is divided by the total area of the buildings to arrive at the percentage of the costs that can be claimed as a deduction. In your case, you have purchased a property on which you are building your principal place of residence. You are also building a studio/granny flat that will be rented out at the commercial rate of rent. The portion of the holding costs incurred relating to the studio/granny flat are not preliminary or of a private or domestic nature. The period of outgoings is not too long as to lose the necessary connection between the outgoing and assessable income and the costs are incurred with the view of gaining or producing assessable income. Continuing efforts are being made in pursuit of that end. Therefore, you are entitled to a deduction for the portion of the holding costs that are incurred in relation to the studio/granny flat on your property under section 8-1 of the ITAA 1997. The deductible expenses you incur will be required to be apportioned to reflect the portion of the property that will be used for private or domestic purposes.