Edited version of private ruling

Authorisation Number: 1011553970445

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Ruling

Subject: rental property expenses

Question 1

Are you entitled to deduct the cost of interest and bank charges incurred on a loan taken out to finance the purchase of land that will be used to earn assessable income?

Answer

Yes.

Question 2

Are you entitled to deduct the cost of rates, land tax and other holding costs on land that will be used to earn assessable income?

Answer

Yes.

Question 3

Are you entitled to deduct the cost of borrowing expenses on a loan taken out to finance the purchase of land that will be used to earn assessable income?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commenced on:

1 July 2007

Relevant facts and circumstances

You and your spouse purchased blocks of land as joint tenants.

The land was purchased for investment purposes, that is to build residential dwellings for renting.

There were delays with the builders in considering the options for construction.

You were also visiting display homes to obtain a suitable house plan and to understand the construction process.

During this time you were talking to banks about obtaining a loan to finance construction of the dwellings.

This process got further delayed due to the global economic crisis.

During these delays you were paying interest on the loan taken out to finance the purchase of the land.

During the delays you have incurred expenses in relation to this loan. These include interest expenses, bank charges, shire and water rates, land tax and other holding costs. You also incurred borrowing expenses related to the loan.

You have now signed building contracts with a builder.

You expect the dwellings will be ready to rent in several months time.

Reasons for decision

Interest, bank charges, rates, land tax and other holding expenses

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.

Expenses incurred relating to a rental property are deductible under section 8-1 of the ITAA 1997, if the property is rented or available for rent in the income year in which you claim the deduction.

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). TR 2004/4 states that interest incurred in a period prior to the derivation of relevant assessable income will be taken as 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.

Although Steele's Case deals with the issue of interest expense, the principles can be applied to other holding expenses on vacant land held for future income earning purposes. These include bank charges, shire and water rates, land tax and other holding costs.

In your situation you purchased blocks of land with the intention of building residential dwellings on them for renting. The interest, bank charges, rates, land tax and other holding expenses associated with your land were incurred after your decision to purchase land and to construct rental properties so that the expenses did not incur at a point too soon and were not preliminary or a prelude to the income earning activity.

As the land was purchased with the intention of deriving assessable income from it, the associated expenses are not private or domestic in nature.

During this period between the purchase of the land and the commencement of construction of your rental properties:

- you had discussions with builders in considering the options for construction

- you visited display homes to obtain a suitable house plan and to understand the construction process

- you were talking to banks about obtaining a loan to finance construction

- the global financial crisis caused further delays but you eventually obtained finance and signed building contracts with a builder.

From the evidence it is clear that throughout the delays you continued your efforts and maintained your intention to construct the dwellings on the land for the purpose of deriving rental income such that the necessary connection between the outgoings and earning assessable income was not lost. It is considered the holding expenses incurred during this time were incurred with one end in view, the gaining or producing of assessable income.

Accordingly, you are entitled to deductions under section 8-1 of the ITAA 1997 for the cost of interest, bank charges, rates, land tax and other holding expenses relating to the purchase and holding of land on which rental properties were constructed in a later income year.

Borrowing expenses

Borrowing expenses are expenses directly incurred when taking out a loan for a property. They include establishment fees, legal fees, stamp duty on the loan and valuation fees. Borrowing expenses will be considered deductible under section 25-25 of the ITAA 1997 to the extent that the borrowed moneys are used or are to be used during that income year for income producing purposes.

Borrowing expenses incurred prior to the commencement of income earning activities may also be deductible. The principles established in Steele's Case and considered in TR 2004/04 (discussed under the heading 'Interest, bank charges, rates, land tax and other holding expenses' above) apply equally to borrowing expenses.

You have taken out a loan to purchase blocks of land on which to construct residential dwellings for the purpose of producing assessable income. As a result of this you have incurred borrowing expenses. As you have incurred the borrowing expenses associated with your land after your decision to purchase and construct income producing assets (your rental properties) the expenses did not incur at a point too soon and were not preliminary or a prelude to the income earning activity.

As the land was purchased with the intention of deriving assessable income from it, the associated borrowing expenses are not private or domestic in nature.

Further, throughout the delays between the purchase of the land and the commencement of construction of your rental properties you continued your efforts and maintained your intention to construct the dwellings on the land for the purpose of deriving rental income such that the necessary connection between the borrowing expenses and earning assessable income was not lost. It is considered the borrowing expenses incurred during this time were incurred with one end in view, the gaining or producing of assessable income.

Accordingly, you are entitled to a deduction for these borrowing expenses. If your total borrowing expenses are more than $100, the deduction is spread over five years or the term of the loan, whichever timeframe is lesser. If you obtained the loan part way through the income year, the deduction for the first year will be apportioned according to the number of days in the year that you had the loan.

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