Private ruling: Rental property deductions
Published: September 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2008

Ruling: Q1: Are you entitled to a claim a deduction for interest paid on borrowings to finance a loan used to acquire the land? | A1: No | Q2: Are you entitled to a claim a deduction for the rates and land tax you have paid in relation to the land? | A2: No

Relevant facts and circumstances: You borrowed money to finance a loan to acquire land in the 200X financial year. You state that the purpose of the loan has always been to make the land an income generating asset via the construction of a property (or properties) to earn rental income. You do not intend to construct and then sell the property (or properties). You state that your intention has always been entirely commercial, and at no time was there a suggestion that you ever contemplated using the asset for private or domestic purposes. You state that the progress of developing the land is linked to the construction of a government project. You state that any commercial decision you make on the construction of a property on the land is reliant on whether the project is fully realised. The feasibility study into the development of the project was released in 200X. In 20YY, a draft development proposal and environmental plan was released. In 20ZZ, part of the project was completed. You state that currently, it is still not certain that all of the proposed project will be fully realised. You have incurred interest expenses on the loan each year since the 200X financial year. You have incurred rates and land tax expenses each year since the 200Y financial year. You have incurred vegetation management expenses in the 200Y and 20XX financial years. You state that in the 200Y financial year you incurred travelling expenses to see your plot of land and to research the types of accommodation on offer and identify what accommodation may work on your land. You state that you have contacted Real Estate agents regarding rental prices and managing rental properties. In the 20ZZ financial year, you had the land surveyed and contour mapped. You state you are exploring the following options: · Construction of a number of studio cabins, or · Subdivide the land into lots, each with its own residential property, or · Subdivide the land into plots, keep one plot and build a rental property on the another plot You do not have a plan in place for the proposed subdivision. You have not engaged an engineer or builder to design/construct any sort of property. You have not sought development approval for any of your proposed options.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1

Reasons for decision: Detailed Reasoning - Detailed reasoning: 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. Taxation Ruling TR 2004/4, at paragraph 9, provides 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. Importantly, the above circumstances may also be used to determine whether other expenses (not just interest expenses) are allowable as deductions prior to the derivation of any assessable income. Paragraphs 30 to 31 of TR 2004/4 discuss situations in which outgoings or expenses may be allowed or disallowed as deductions. The ruling discusses deductions in terms of subsection 51(1) of Income Tax Assessment Act 1936 ; however, the ruling has equal application to section 8-1 of the ITAA 1997. …There are cases where the necessary connection between the incurring of an outgoing and the gaining or producing of assessable income has been denied upon the ground that the outgoing was 'entirely preliminary' to the gaining or producing of assessable income or was incurred 'too soon' before the commencement of the business or income producing activity. The temporal relationship between the incurring of an outgoing and the actual or projected receipt of income may be one of a number of facts relevant to a judgment as to whether the necessary connection might, in a given case, exist, but contemporaneity is not legally essential, and whether it is factually important may depend upon the circumstances of the particular case. As Lockhart J said in FC of T v. Total Holdings (Australia) Pty Ltd: ...[I]f a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income earning activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under s 51. ... I say 'generally' as some qualification may be necessary in appropriate cases, for instance, where interest is paid by a taxpayer as a prelude to his being in a position whereby he may commence to derive income. In such cases the requirement that the expenditure be incidental and relevant to the derivation of income may not be satisfied. It is well accepted that expenditure can satisfy the positive limbs of subsection 51(1) even though it is incurred in a period prior to any expected resultant income. Even so …those limbs will not be satisfied if that expenditure is 'too soon', 'preliminary' or a 'prelude': · An outgoing may be 'too soon' in the sense that a significant delay between the incurring of an outgoing and the actual or projected receipt of income may be relevant in determining whether expenditure is deductible; and · An outgoing may be 'too soon' in the sense that the advantage conferred by the expenditure is necessary for, but not to be found 'in', the regular income earning activities ('functionally too soon'). Such a situation can arise even in the absence of the above mentioned 'significant delay'. | Detailed Reasoning - Application to your circumstances: You took out a loan to purchase land in the 200X financial year. You state that your intention was always to earn assessable income from the land as you intend to construct a property on the land and rent the property out. You state that you have never contemplated using the land for private or domestic purposes. You state that the progress for developing your land is linked to the construction of a project and that any commercial decision you make on the construction of a property on the land is reliant on whether the project is fully realised. However, at this point in time, it is not certain that the project will be fully realised. Importantly, in order for a deduction to be allowed under section 8-1 of the ITAA 1997, you must be able to establish that there is a necessary connection between the expenditure incurred and the earning of assessable income and that you are making a continued effort in pursuit of the generation of assessable income. To the present date, some years since you purchased the land, there has been minimal activity on your part in actively pursuing a venture to earn assessable income. This is evidenced by; · You are yet to commit to a particular type of development on the land · You are yet to commit to the use of all the land in earning assessable income · You do not have any plans in place for a subdivision of the land · You are yet to engage professionals that would be required for the venture (engineers, builders etc.) · You have not sought development approval for your property · You are yet to commit to a time frame for the commencement of construction of the income earning property. · You have provided no indication of when you expect construction of the income earning asset to be completed or when actual or projected income is expected to be received It is not enough to state that expenditure or activity on the project undertaken by other entities (eg. contractors and/or government) creates a link between your expenses and the earning of your assessable income. You must be able to show that you are actively pursuing the generation of assessable income. Based on the information provided, you have not undertaken sufficient activity on the venture to indicate that you are actively pursuing the generation of assessable income. You appear to be simply holding the land until a decision is made on the realisation of the track. Further, there is no indication when, or if, any assessable income will be derived from the activity in the near future. Therefore, we consider that the outgoings you have incurred thus far have been incurred at a point 'too soon' for the expenditure to be deductible, and, that you have not made a continued effort to realise the generation of assessable income such that the venture has become dormant. Accordingly, you cannot claim a deduction for the interest and general expenses incurred under section 8-1 of the ITAA 1997. While you may not be able to claim an immediate deduction for these expenses, you may be able to include these 'costs of owning the asset' as third element costs in calculating the cost base of the land.