Private ruling: Rental property expenses
Date of advice: 25 September 2015
Published: November 2015
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for the interest expenses incurred on funds borrowed for the acquisition of your investment property? | A1: Yes. | Q2: Are you entitled to a deduction for the interest expenses incurred on funds borrowed for the restoration work undertaken on your investment property? | A2: Yes. | Q3: Are you entitled to a deduction for the rates, land tax, electricity and gas expenses, strata fees, insurance and maintenance costs during the restoration work? | A3: 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 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 ( Munro's case ) is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income. That is, it is generally accepted that interest incurred on funds borrowed to acquire an income producing asset is an allowable deduction. 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 considers deductions for interest expenses 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 ) as well as the decisions in the Full Federal Court . 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. Taxation Ruling 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. In your case, your property was previously rented, however was not rented for an extended period due to the restoration works being carried out. Although rental income from the property was not derived for some time, it is considered that there is a sufficient connection to the earning of your assessable income. It is also considered that continuing efforts were being undertaken to earn assessable rental income and the requirements as outlined above are met. Consequently a deduction is allowable for the interest expense incurred on the loans under section 8-1 of the ITAA 1997. Similarly the holding costs incurred while the property is being restored such as rates, land tax, electricity and gas expenses, strata fees, insurance and maintenance costs are sufficiently connected to the earning of your assessable income and are allowable deductions.

Relevant facts: You purchased a rental property. | You are the sole owner of the property. | You borrowed funds for the purchase of the property. | At the time of purchase you intended that the property would be rented out. This intention has not changed since the date of purchase. | The property was rented to an unrelated party for more than a year. | An area of the property was found to be severely water damaged. Leaking water was causing inconvenience to the tenants as well as damage to the apartments below. A large number of tiles had to be removed to try and ascertain the source of the leak. | As a result of the water damage, you were advised that you had no choice but to replace the relevant area of the property. | Having ascertained the extent of the works needed to make good the property, you decided to concurrently renovate the old fit out that existed. | The extensive nature of the works meant that they could not be undertaken while the property continued to be occupied. | The tenant vacated the property. | You engaged an architect to draw up plans for the repairs and renovations to the property. | Given the extensive nature of the repairs planned, a number of town planning reports were commissioned, consultation with neighbours was necessary and approval by way of a formally submitted development application was required. It took a number of months for the above to be completed. | Subsequently the development application was submitted to the council and approved less than six months later. | Discussion with the builder regarding the works required and resolving strata issues occurred. | The request for a construction certificate was submitted and issued a number of months later. | Interior design plans occurred. | The works took place. Further design planning, landscaping and variations occurred. | Construction was completed several months later. | The restoration work costs were funded through a separate loan facility. | You incurred costs for rates, land tax, electricity and gas expenses, strata fees, insurance and maintenance costs during the restoration work. | Following completion of the restoration work, you immediately made the property available for rent. | The property was leased soon after. | The property has never been used for private purposes.