Edited version of private ruling

Authorisation Number: 1011579828962

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Ruling

Subject: Rental Deductions

Are interest expenses, borrowing costs, council rates and water authority rates incurred in relation to the construction of a rental property allowable deductions pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), where the intention (to rent the property) changes prior to the derivation of any rental income?

Yes.

This ruling applies for the following period:

1 July 2005 - 30 June 2008

Relevant facts and circumstances

You purchased vacant land under a contract entered into. Settlement date was prior to 1 July 2006.

Your intention was to construct a rental property on the land and derive rental income from the 'investment'.

You obtained a market value rental figure from a real estate agent.

You took out two investment loans from the bank. The first loan was to finance the purchase of the vacant block of land, and the second loan was to finance the construction of the house.

Your original mortgage application included the potential earnings from the rental property as a factor in the loan assessment.

You engaged the services of a builder to construct the house, which was completed in 2008.

Once the builder completed the construction of the house in 2008, you attended to 'finishing off' the remaining smaller items so the property was in condition to be rented. This process took several months and was completed in later in 2008.

At this point, which occurred in the 2008-09 tax year, your intention with regard to the property changed and you decided to keep the house for private use.

Your intention changed, you were in a better financial position and could afford to keep the property without subsidising the mortgage repayments with rental income.

Since your intention changed, the property has been either vacant or used as a holiday home.

The property has never been rented or been put on the market available to rent.

In 2005-06, 2006-07 and 2007-08 tax years you claimed deductions in relation to the property for interest, borrowing costs and rates.

You did not make a claim for expenses relating to the property in the 2008-09 income tax return.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-25

Income Tax Assessment Act 1997 Subsection 25-25 (4)

Income Tax Assessment Act 1997 Subsection 25-25 (6)

Reasons for decision

Summary

Your interest expenses, borrowing costs, council rates, and water authority rates are allowable deductions under section 8-1 of the ITAA 1997.

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, or relate to the earning of exempt income.

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, which deals with the implications of Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's Case), states in paragraph 9 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.

Australian Taxation Offices publications Rental properties 2008-2009 (NAT 1729) provides that if you take out a loan to purchase land on which to build a rental property or to finance renovations to a property you intend to rent out, the interest on the loan will be deductible from the time you took the loan out. However, if your intention changes - for example, you decide to use the property for private purposes and you no longer use it to produce rent or other income - you cannot claim the interest after your intention changes.

In your case, you sought an appraisal from a real estate agent to obtain a market value rental figure for rental properties in the surrounding area of your investment property. You purchased land in 2006 and engaged the services of a builder to construct a house, which were completed in 2008. You attended to 'finishing off' the remaining smaller items so the property was in a condition to rent which took three to four months. You state your intention (to rent out the property) changed in the 2008-09 tax year and have decided to keep the property for private purposes.

In these circumstances, it is considered that the interest expenses on funds borrowed for the purchase of the land and construction costs of your investment property were not incurred at a point 'too soon', and were not preliminary to the commencement of the income earning activity. Furthermore, your intention was to use the property for an incoming producing purpose once it was completed and there was no private or domestic purpose when you entered the arrangement.

You made continuing efforts, you took out an investment loan, sought an appraisal from a real estate agent, engaged the services of a builder to construct a house, and attended to 'finishing off' the property, which all evidence a commitment to a future income producing activity.

Accordingly, you are entitled to a deduction under section 8-1 of the ITAA 1997 for the interest expenses incurred in relation to the purchase of the land and construction costs of your investment in 2005-06, 2006-07 and 2007-08 tax years.

While Steele's Case deals with the issue of interest, the principles can be applied to other types of expenditure including council rates and water authority rates.

Borrowing costs

Section 25-25 of the ITAA 1997 provides that a taxpayer can deduct expenditure incurred in borrowing money to the extent that those funds are used for the purpose of producing assessable income. Some examples of borrowing expenses include establishment fees, broker's commission, valuation fees and stamp duty on the loan.

Subsection 25-25(6) of the ITAA 1997 states that borrowing costs not exceeding $100 are fully deductible in the year in which they are incurred. If the total borrowing costs exceed $100, the deduction is spread over the period of the loan or five years, whichever is the shorter period. Subsection 25-25(4) of the ITAA 1997 sets out the process for calculating the deductible amount for an income year where the borrowing expense exceeds $100.

Your borrowing expenses were incurred with regard to the purchase of the land and the construction of the investment property that was to be used solely for an income producing purpose.

Accordingly, you are entitled to a deduction under section 25-25 of the ITAA 1997 for your borrowing expenses incurred in 2005-06, 2006-07, and 2007-08 tax years.

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