Private ruling: Rental property - interest deductions
Published: September 2014
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to claim a deduction for the interest on a loan taken out to acquire an investment property where the property has not yet been constructed? | A1: Yes | Q2: Are you entitled to claim X% of the interest expenses where the legal title will be registered as tenants in common, with you holding a X% interest and your spouse holding the remainder? | A2: Yes

Relevant facts and circumstances: You have entered into a contract to purchase an apartment. The apartment will be used to produce assessable income. The purchase was 'off the plan' and you have been advised in writing by the developer that construction will commence shortly. Completion of construction is expected in 2016. Your purchase will settle around the same time that construction is completed. The title for the property will be registered as tenants in common - you will hold X% and your spouse will hold the remainder. You are required to pay a deposit to secure the purchase of the property. To finance the deposit you and your spouse will obtain a standalone loan facility from your bank. Your main residence will be the security for the loan.

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

Reasons for decision: Detailed Reasoning - Expenses incurred prior to income: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature. In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. In considering the above decision Taxation Ruling 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 situation, you will incur interest charges on borrowed funds used to pay a deposit on an investment property that was purchased 'off the plan'. The construction will commence shortly, due to be completed in 2016. In your circumstances the interest expense will not be considered to have been preliminary or incurred at a point too soon before the commencement of the income producing activity. The length of time between entering into the contract and the commencement of construction will not be so long that the necessary connection between the interest outgoings and the assessable income is lost. Accordingly, you are entitled to a deduction for the interest expenses under section 8-1 of the ITAA 1997. | Detailed Reasoning - Note:: It is important to note however, the interest will only be deductible as long as your intention to hold the property for income producing purposes remains the same. If your intention changes and you no longer hold the property for rental income purposes, you cannot claim a deduction for the interest after your intention changes. | Detailed Reasoning - Apportionment of expenses: Taxation Ruling TR 93/32 explains that the loss or income from a rental property must be shared according to the legal interest of the owners, except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title. This is regardless of whether the parties have agreed, either orally or in writing, to apportion the income and expenses on some other basis. Paragraph 41 of TR 93/32 states We consider that there are extremely limited circumstances where the legal and equitable interests are not the same and that there is sufficient evidence to establish that the equitable interest is different from the legal title. We will assume where taxpayers are related, e.g., husband and wife, that the equitable right is exactly the same as the legal title. In this case, where the legal title will be registered as tenants in common with you holding a X% interest and your spouse holding the remainder, the interest expenses should be deducted in that same proportion. Accordingly, you are entitled to deduct X% of the interest expenses.