Private ruling: Investment property expenses
Published: January 2015
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for land tax, firebreak, rates and interest expenses incurred prior to xx/xx/2014? | A1: No. | Q2: Are you entitled to a deduction for rates, land tax and interest expenses incurred after xx/xx/2014 in relation to your block of land where continuing efforts are made to construct an investment property? | A2: Yes.


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, 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 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. 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 ( Temelli's 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 Temelli's 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 Council's 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 Temelli's 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. As stated in TR 2004/4, to be entitled to claim interest deductions, income producing activities should commence in a reasonable period of time. You purchased the block of land several months ago, however, there is no information to show that building of the investment property has yet commenced. Although your intention in purchasing the land has always been for income producing purposes, the length of time between the purchase of the land and the commencement of building is considered to be so long that the venture has become dormant. The reason for the delay in constructing the property was your financial position and not any factors intrinsic to the property development itself. It is not considered that you made continuing efforts in respect of constructing the rental property on the land. That is, the period of time between the purchase of the land and commencement of construction is considered to have been so long that the necessary connection between the interest and other holding costs and assessable income is lost. We acknowledge your personal circumstances, however it is considered that continuing efforts to derive assessable income have not been made. Accordingly, you are not entitled to a deduction for the interest expenditure or other costs you incurred in relation to your vacant land. The facts in your case can be distinguished from Steele's Case where a significant amount of work was done in an effort to make the property income producing. Your case is similar to Temelli's Case in that little attempts have been made in building a rental dwelling. That is, you have not demonstrated the required commitment to the project, as established in Steele's Case , and the necessary connection between the outgoings and the assessable income is not present. However, on xx/xx/2014, you contacted a builder in relation to your investment property. You have now applied for finance for the construction costs. This indicates that efforts are now being made to construct your investment property. It is considered that the conditions outlined in TR 2004/4 are now being met and therefore a deduction for your interest expenses, land tax and rates incurred from xx/xx/2014 is allowable. Where continuous efforts are being made and the property is ready to rent in a reasonable time, you are able to claim the relevant interest, land tax and rates under section 8-1 of the ITAA 1997.

Relevant facts: You signed a contract to purchase a block of vacant land with the intention to build an investment property. | You borrowed in relation to the land purchase. You incurred interest expenses in the relevant financial year. You continue to incur interest expenses on this loan. | Due to finance issues, you were unable to get a loan for construction. | On xx/xx/2014 you contacted a builder and obtained a quote. You contacted another builder. | You are currently applying for finance. | You expect the investment property to be completed and ready for rental in the next financial year. | You incurred expenses for land tax and a firebreak in the subsequent financial year. | You have also incurred costs for shire and water rates.