Private ruling: Rental property deductions - interest and other
Published: September 2011
Ruling period: Year ended 30 June 2010 | Year ended 30 June 2011
Date scheme commenced: 1 July 2009

Ruling: Q1: Are you entitled to a deduction for interest and holding costs incurred on your vacant block of land? | A1: No | Q2: Are you entitled to a deduction for the cost of fencing erected on your vacant land? | A2: No

Relevant facts and circumstances: You purchased a vacant block of land. Your intention was to build a house on the land to rent out, when you could afford to. You borrowed the full amount of the purchase price. The loan is on an interest only basis. You pay council rates and public liability insurance for the property and have paid to erect X dividing fences on the land. You have not built a house yet. You have not engaged a builder, nor selected house plans. You have spoken to real estate agents in the area about the rental market. You have stated your financial circumstances have changed recently so you may be able to start building your house in the near future. You intend to use the equity in your existing residential property to obtain finance to fund the building project.

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

Reasons for decision: Summary: You are not entitled to a deduction for interest expenses and holding costs for your vacant land because the expenditure is not in relation to an income-producing property. | 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. Generally, expenses incurred relating to a rental property are deductible if the property is rented or available for rent in the income year in which you claim the deduction. It is noted that you have been provided with information from the ATO that you can claim interest, rates and taxes, insurance and fencing expenses for land on which you intend to build a rental property. Whilst this may be the case in some circumstances, in order for the expenses to be deductible several conditions must be met. Taxation Ruling TR 2004/4 provides guidance on when interest on a loan used to purchase land on which a person intends to build a rental property is deductible. TR 2004/4 considers the decision in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR459 ( Steele's case ) and 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 · continuing efforts are undertaken in pursuit of that end. While Steele's case deals with the issue of interest, the principles can be applied to other types of expenditure including council rates and insurance expenses. TR 2004/4, in considering the final of the above conditions, states that a test of 'continuing efforts' would need to be set within the context of the normal time frames of the relevant industry. However, if a venture becomes truly dormant and the holding of the asset is passive, relevant interest will not be deductible even if there is an intention to revive that venture some time in the future. In your case your intention has always been to build a rental property on the land once your financial position allowed you to do so. However since purchasing the land, there have been no efforts made to build on it. Your plans are dormant at present and your holding of the asset is passive, even though you intend to build the house at some time in the near future. The reason for the delay has been your financial position and not any factors intrinsic to the property development itself. Accordingly you are not entitled to a deduction for the interest expense and holding costs you incur in relation to your vacant land. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the 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. Fencing is expenditure of a capital nature therefore you are not entitled to a deduction for the cost of erecting fencing on your vacant land. | Detailed Reasoning - Capital gains tax: You should retain records of the expenses in respect of your vacant land. These expenses may form part of the cost base of this asset for the purposes of calculating any potential future capital gain. | Detailed Reasoning - Deduction for capital expenditure: Division 43 of the ITAA 1997 allows a deduction for certain capital expenditure on assessable income producing buildings and other capital works. Subsection 43-20(3) includes fencing as an example of deductible capital expenditure. Once construction of the building is completed, you may be able to claim a deduction for the fencing costs under this provision. Page 19 of Rental Properties 2011 NAT 1729-6.2011 provides more information on capital works deductions.

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