Private ruling: Rental property expenses
Published: March 2013
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: Where you refinance your loan on dwelling 1, will the interest expenses on the loan be an allowable deduction when dwelling 1 is rented? | A1: No. | Q2: Are you entitled to a deduction for your share of the interest expenses on the total of your loan? | A2: No. | Q3: Are you entitled to a deduction for your share of the interest expenses incurred on the portion of your loan that relates to the work carried out on dwelling 1? | A3: Yes. | Q4: Are you entitled to a deduction for your share of interest expenses on the relevant portion of your original loan balance when the property becomes available for rent? | A4: Yes. | Q5: Where you redraw funds from your loan and use them for work on dwelling 1, are you entitled to a deduction for your share of interest expenses on these funds? | A5: Yes. | Q6: Where you redraw funds from your loan and use them for the application fees for the garage and other work on dwelling 1, are you entitled to a deduction for your share of interest expenses on these funds? | A6: Yes. | Q7: Are you entitled to claim a capital works deduction for your portion of the following expenditure incurred on dwelling 1 when it becomes available for rent: · improvements previously carried out · new single garage · driveway for rental property · improvements to bathroom? | A7: Yes. | Q8: Are you entitled to a deduction for your portion of the decline in value for the blinds and curtains in dwelling 1 once the property is available for rent? | A8: Yes. | Q9: Are you entitled to a deduction for landscaping? | A9: No.


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

Reasons for decision: Detailed Reasoning - Interest expenses: 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. Taxation Ruling TR 95/25 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, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put. The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to a person's main residence or other private purpose, no deduction is allowed. As noted in Taxation Determination TD 93/13, the deductibility of interest is determined by the use of the borrowed money and not by the security given for the borrowed money. That is, what property is used as security for your loan is not relevant for taxation purposes. Consequently if you were to re-mortgage dwelling 1 before renting it out the interest on the remortgaged amounts would not be deductible unless the use of the funds was for a deductible purpose. In your case the use of the funds would not be to purchase dwelling 1 but to build dwelling 2 and thus the funds would not be used for a deductible purpose. | Detailed Reasoning - Redrawn funds: Taxation Ruling TR 2000/2 considers the deductibility of interest incurred by borrowers on money drawn down under line of credit facilities and loans offering redraw facilities. The ruling establishes drawing any excess or available funds from the loan is treated as a new loan. As such the purpose or use of the drawing is relevant. That is, the deductible portion of interest when further borrowings are made depends on the use to which the redrawn funds are put. In your case, where you redraw funds from your original loan account, we need to consider the use of these funds. Therefore where you use redrawn funds from your loan to do work on dwelling 1, your rental property, the interest expenses incurred on these redrawn funds is an allowable deduction. This is because the borrowed funds are being used for income producing purposes. The nexus between your interest expenses and your assessable rental income is sufficient. Therefore a deduction is allowable under section 8-1 of the ITAA 1997. | Detailed Reasoning - Apportionment: Co-owners of a rental property divide the income and expenses for the rental property in line with their legal interest in the property (Taxation Ruling TR 93/32). In your case you borrowed money to build your new home. The money used to build your new home is private in nature and no deduction is allowable. However, some of the borrowed funds were used to carry out works on your previous residence that will be rented. This portion of the loan is for income producing purposes. Therefore the interest expenses are deductible under section 8-1 of the ITAA 1997. Your original loan has a balance outstanding. These funds were borrowed for private purposes, that is, for your main residence. You now wish to use some of your land to build your new home and use the original dwelling as a rental property. As some of the land will be used for income producing purposes, and some of the land is used for private purposes, a portion of this original loan will be deductible. Where an expense comprises deductible and non-deductible components, then apportionment of the expense is required. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances. | Detailed Reasoning - When deduction is allowable: 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 ). 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 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 the 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. In your case, a portion of your loan was used to improve the property that will be rented out. As this portion of the loan relates to the derivation of your rental income, you are entitled to a deduction for your share of the interest incurred on these funds when the loan is taken out. | Detailed Reasoning - Capital works: Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a residential property is used for income producing purposes. Subsection 43-25(1) of the ITAA 1997 provides that the rate of deduction for capital works which began after 26 February 1992 for a residential rental property is 2.5%. However, a deduction cannot be made prior to the completion of the capital works (section 43-30 of the ITAA 1997). The costs incurred in building a garage, driveway and carrying out improvements to dwelling 1 are regarded as construction expenditure for which a deduction is available under section 43-10 of the ITAA 1997. | Detailed Reasoning - Depreciating assets: Section 40-25 of the ITAA 1997 allows a deduction for the decline in value (depreciation) of a depreciating asset you hold, to the extent the asset is used for a taxable purpose. Blinds and curtains are regarded as depreciating assets for Division 40 of the ITAA 1997 purposes. A deduction for their decline in value is an allowable deduction where they are used for income producing purposes. | Detailed Reasoning - Landscaping: Landscaping work is considered to be an improvement and not a repair. Therefore no deduction is allowable under section 25-10 of the ITAA 1997. Subsection 43-70(2) of the ITAA 1997 excludes certain expenditure from 'construction expenditure'. Expenditure on landscaping is so excluded (paragraph 43-70(2)(d) of the ITAA 1997). Therefore no deduction is allowable under Division 43 of the ITAA 1997. No other provision is relevant in relation to the landscaping costs, therefore no deduction is allowable. However, the landscaping costs may be included in the cost base for capital gains tax purposes.

Relevant facts: Your home is on a large block of land with one residence. The property was constructed before 1985. | The property is held in joint names. | The property has an outstanding mortgage. | Since owning the property you had improvements and renovations carried out. | You are currently in the process of building a second dwelling (dwelling 2) on the land. This second dwelling will become your main residence. | You will then rent out the original dwelling (dwelling 1). | You have borrowed money to build dwelling 2. Some of the borrowed funds were also used to do work on dwelling 1. | You built an additional garage for dwelling 1. | You installed a new driveway which will service both dwellings. | You used some money to upgrade the bathroom in dwelling 1.