Private ruling: Deductibility of rental property interest expense and borrowing costs
Published: August 2014
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to a deduction for interest expenses incurred on a loan taken out to purchase and construct an investment property? | A1: Yes. | Q2: Are you entitled to a deduction for lender's mortgage insurance (LMI) incurred regarding the loan taken out to purchase and construct the property? | A2: Yes. | Q3: Are you entitled to a deduction for stamp duty and legal expenses incurred regarding the purchase of the property? | A3: No.

Relevant facts and circumstances: You purchased land to build an investment property. Upon the completion of construction, the property was rented out. You paid interest on the loan used to purchase the land and fund progress payments to the builder for the construction of the house. You have incurred interest on borrowed money to purchase the land and construct the property. You have also incurred borrowing costs relating to the purchase of the land including stamp duty for the transfer of the property title, legal costs including solicitors' fees for the purchase of the property, and lender's mortgage insurance (LMI).

Relevant legislative provisions: Income Tax Assessment Act 1997 (ITAA 1997) section 8-1 | Income Tax Assessment Act 1997 (ITAA 1997) section 25-25

Reasons for decision: Summary: You are entitled to claim a deduction for interest expenses incurred on your loans, under section 8-1 of the ITAA 1997 because it was incurred in the production of assessable income. You are entitled to a deduction for LMI expenses under section 25-25 of the ITAA 1997 because the loan was incurred for income producing purposes. Expenses incurred in to procure the property are capital in nature and are therefore not deductible under section 8-1 of the ITAA 1997. | 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. 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. 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, you have incurred interest on investment loans which were used to purchase a block of land and construct an investment property. Since the completion of construction, the property has been rented out. The period of time of time between the purchase of the block of land and the availability of the property for rent is not considered so long that the necessary connection between interest outgoing and the derivation of income is lost. Accordingly, you are entitled to claim a deduction for interest expenses incurred on the loans, under section 8-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: You are entitled to a deduction for LMI expenses under section 25-25 of the ITAA 1997 because the loan was incurred for income producing purposes. | Detailed Reasoning - Detailed reasoning: Expenditure incurred in borrowing money is capital expenditure and would not be deductible under section 8-1 of the ITAA 1997. However, section 25-25 of the ITAA 1997 allows a deduction for certain borrowing expenses, to the extent that the money is used for producing assessable income. While the afore mentioned Steele's Case deals with the issue of interest, the principles can be applied to other types of expenditure including borrowing costs. This was the case with ATO ID 2001/478 where borrowing expenses were incurred with regard to the purchase of land and the construction of a house intended to be used solely for income producing purposes. The borrowing expenses were not considered to have been incurred at a point 'too soon' before the commencement of the income producing activity. Borrowing costs which are considered deductible under section 25-25 of the ITAA 1997 are expenses directly incurred when taking out a loan for a property. They include establishment fees, legal fees, valuation and survey fees, and stamp duty on the loan etc. They are deductible to the extent that the borrowed monies are used during that income year for the purpose of producing income. Your costs in relation to the loan taken out for the purpose of purchasing land and construction of an investment property include the lender's mortgage insurance (LMI). Since your loan was incurred for the purpose of producing income, the expense you incurred for your LMI is considered a deductible borrowing cost. Accordingly, you are entitled to a deduction for the LMI expenses under section 25-25 of the ITAA 1997. Where the total borrowing costs exceed $100, the claim must be apportioned over the period of the loan or five years, whichever is the lesser. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for expenses which are incurred in the earning of assessable income to the extent they are not of a capital nature, private or domestic, or for the earning of exempt income. Borrowing costs which are considered capital in nature are not deductible. Such costs include stamp duty on the property title transfer, legal expenses including solicitor's fees for the purchase of the property and insurance premiums where your loan will be paid out in the event of tragic circumstances, such as death disability or unemployment. Your costs in relation to the purchase of your land are capital expenses and are therefore not an allowable deduction under section 8-1 of the ITAA 1997. These costs, however, form part of the cost base and reduced cost base of the property.