Private ruling: Rental property expenses
Published: August 2013
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you eligible for a deduction for any portion of the interest incurred on a loan for a holding deposit for an investment property prior to settlement? | A1: Yes. | Q2: Can you claim a deduction for a portion of the interest actually incurred on an investment loan linked to an offset account? | A2: Yes.

Relevant facts and circumstances: You are purchasing a property off the plan with the sole intention of renting it under the National Rent Affordability Scheme (NRAS). You have entered into an NRAS agreement with a management company. NRAS is a Commonwealth Government scheme designed to encourage large-scale investment in affordable housing by offering tax and cash incentives to providers of new rental dwellings. Entitlement to these incentives is subject to certain conditions being met by the property owner, including that the approved dwellings are rented to eligible tenants at an amount of at least 20% below market rates. The NRAS incentives offered are annual incentives, generally comprising of: · a Commonwealth Government incentive made by way of a refundable tax (Division 380 of the Income Tax Assessment Act 1997 (ITAA 1997) · a cash payment from the relevant state government, which is not assessable and not exempt (NANE) income (section 380-35 of the ITAA 1997). You will incur expenses in respect of the rental property, including insurance, repairs and loan interest. You paid the required holding deposit and a further amount on exchange of contracts. You have incurred interest on these amounts. Settlement of the property is expected within 12 months of the initial holding deposit, when the property will become income producing. You intend to borrow the value of the property purchase, and also an additional amount will be borrowed to be used progressively for ongoing expenses relating to the property. The additional amount will be placed in an offset account and drawn down as needed only for expenses relating to the investment property.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 and | Income Tax Assessment Act 1997 Section 380-35.

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. It is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. Taxation Ruling TR 2004/4 in considering the decision of the High Court in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 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 where: · 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 purchased a property off the plan, with an intention to build an income producing property and rent it under the National Rent Affordability Scheme (NRAS). There is no private or domestic purpose for holding the property. As construction is expected to be completed within twelve months, followed by income production, the necessary connection between the interest expenses and rental income still exists. As the expenses you incurred in relation to the property were incurred solely for income producing purposes, they are not considered to have been incurred at a point 'too soon' prior to the commencement of the income producing activity. Therefore you will be entitled to a deduction for a portion of the interest incurred. | Detailed Reasoning - National Rent Affordability Scheme: Subsection 8-1(2) of the ITAA 1997 states you cannot deduct a loss where the outgoings are of a capital, private or domestic nature, or incurred in producing NANE income. It is generally accepted that expenses incurred in respect of a rental property are considered to be incurred in the course of gaining or producing assessable income and are therefore deductible. Apportionment of expenditure is necessary where it serves both an assessable income producing end and some other end: ( Ronpibon Tin NL v FC of T (1949) 8 ATD 431). While derivation of assessable income by way of rent is one objective achieved by participation in NRAS, the receipt of government incentives, including state government NANE income is another. The costs associated with making your property available as an NRAS rental property would need to be apportioned to reflect the derivation of associated assessable income and NANE income. Expenses are not deductible to the extent they are incurred in gaining NANE income (paragraph 8-1(2)(c) ITAA 1997). Accordingly rental expenses incurred in respect of an NRAS rental dwelling must be apportioned, limiting a claim for any deduction to the portion of costs relating to the derivation of assessable income. Generally this apportionment of expenses would be made using the following formula to calculate the percentage of deductible expenses: Otherwise deductible expense x assessable rental income derived from the property / (assessable rental income + NANE income associated with the property) In your case, where there has been no income production until the property is completed and rented, until this time you would apportion the expenses according to the percentage of rent you will derive compared to market value. Under the terms of the NRAS, as you will rent the property to eligible tenants at least 20% below market rates, for the period of construction until the property is rented you would also be limited to apportioning the expenses you can claim to at least 20% less than the actual amount of expense. | Detailed Reasoning - Investment loan linked to offset account: Taxation Ruling TR 93/6 considers loan account offset arrangements which are used to reduce the interest payable on a customer's loan account. TR 93/6 provides that an acceptable loan account offset arrangement with dual accounts operates as follows: · There are two accounts; a loan account and a deposit account. · No interest is received on the deposit account · The interest on your loan can only be reduced to the extent of the amount of interest which would have been charged on the loan amount equal to the balance of your deposit account. For example, you have a loan of $250,000 and a credit balance in your deposit account of $50,000. You can only obtain a maximum reduction of interest as if the balance of your loan was $200,000 (reduced by the $50,000 balance of your deposit account). A taxpayer with an acceptable loan account offset arrangement with dual accounts is entitled to claim a deduction for the full amount of interest actually incurred on the loan account whilst the loan is used wholly for income producing purposes. This will remain the case even if funds are withdrawn from the deposit account and used for non-income producing purposes. This is because depositing funds into the deposit account will decrease the interest payable on the loan account but will not decrease the balance of the loan account and withdrawing funds from the deposit account will increase the interest payable on the loan account but will not increase the balance of the loan account. TR 93/6 states, at paragraph 17, that, if the loan account offset arrangement links a savings account with a loan on which the interest is deductible, the interest deduction allowable to the customer cannot exceed the reduced amount of interest (i.e., the interest payable after the offset has been taken into account) actually incurred by the customer. In your case, if you have set up an acceptable loan account offset arrangement with the following features: · Dual accounts; a loan account and a deposit account. · No interest is received on credit balances held in the deposit account. · The interest payable on your loan account is reduced by amount of interest that would have been charged on an amount equal to the balance of your deposit account. Therefore, you will be entitled to a deduction for a portion of the amount of interest you actually pay. The deductible interest is calculated using the NRAS apportionment principles.