Edited version of private ruling

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Ruling

Subject: Rental property deductions

Question:

Are you entitled to deductions for interest, rates and insurance incurred on properties that are available for rent?

Answer: Yes.

This ruling applies for the following period:

1 July 2009 to 30 June 2010.

The scheme commenced on:

1 July 2009.

Relevant facts:

You are the sole owner of two vacant lots of land (the vacant lots).

The vacant lots are adjacent to another block of land which you have an ownership interest in.

This other block of land has a vacant commercial premises on it.

The vacant lots and the commercial premises have advertised for lease as one parcel and been available for rent as one parcel for several years.

There is a sign on the properties advertising them for rent and they are listed with the local real estate agent as being available for rent.

You are seeking this ruling in relation to the vacant lots only and for a particular income tax year only (the relevant income tax year).

You incurred costs for interest, rates and insurance in respect of the vacant lots in the relevant income tax year.

You financed the vacant lots with a loan. Only X% of the loan relates to the vacant lots.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Rental expenses - general

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.

For a deduction to be allowed under section 8-1 of the ITAA 1997, there must be a sufficient connection between the expense and the activity which produces the assessable income. Generally, such a connection will exist when an outgoing is 'incidental and relevant' to the income producing activity.

In the case of an income producing rental property, examples of expenses generally allowed as deductions because there is a sufficient connection between the expense and the income producing activity include:

· interest on a loan used to acquire the property,

· Council rates on the property, and

· the cost of insuring the property.

An allowable rental expense will either be deductible as an immediate deduction in the income year the expense is incurred, or over a number of years.

Interest, rates and insurance costs in respect of a rental property are generally deductible in full in the year they are incurred by the legal owner of a rental property.

An allowable deduction may be required to be apportioned in some cases. For example, where only a portion of a loan relates to an income producing activity, then only the same portion of the interest incurred on the loan can be deducted.

Expenses incurred prior to the commencement of a relevant income earning activity

To be deductible, it is not necessary that an outgoing should produce assessable income in the same year in which the expense is incurred.

This principal has been accepted by the Courts which have previously accepted that expenditure can satisfy the requirements for deductibility specified in section 8-1 of the ITAA 1997, even though the expenditure is incurred in a period prior to the earning of expected income (Ronpibon Tin NL and Tongkah Compound NL v. FC of T (1949) 78 CLR 47).

Taxation Ruling TR 2004/4 contains the Australian Tax Office (ATO) view on the circumstances when interest incurred before income is earned from the relevant activity will be deductible.

TR 2004/4 considers the implications of the decision of the High Court in Steele v. FC of T 99 ATC 4242 (1999) 41 ATR 139 (Steele's case) and specifies that interest incurred in a period prior to the derivation of relevant assessable income will be considered to have been incurred in gaining or producing the relevant 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 only dealt with the issue of whether interest could be deducted prior to the earning of assessable income, the same principles can be applied to other types of expenditure, including rates and insurance.

In your case:

· You intend to use the vacant lots solely for income producing purposes.

· There is no private or domestic purpose associated with your ownership of the vacant lots.

· You have made continuing efforts to find a tenant by having the vacant lots listed with a real estate agent as being available for rent (albeit as one parcel along with the commercial premises).

· You incurred expenses for interest, rates and insurance in relation to the vacant lots.

· We consider that the interest, rates and insurance expenses you incurred on the vacant lots in the relevant income tax year were not incurred 'too soon' to be deductible. They were neither preliminary, nor a prelude, to the expected income earning activity because the vacant lots were available for rent at the time the expenses were incurred.

· The vacant lots were available for rent for a period of about 20 months up to the end of the relevant income tax year. We do not consider this length of time to be so long that the necessary connection between the outgoings and the expected assessable income was lost.

Conclusion

The interest, rates and insurance expenses you incurred in relation to the vacant lots in the relevant income tax year were incurred in gaining or producing your assessable income.

You are entitled to a deduction for those expenses under the provisions of section 8-1 of the ITAA 1997.

In relation to the interest, your allowable deduction will be X% of the interest incurred on the loan.

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