Edited version of your private ruling

Authorisation Number: 1012467190474

Ruling

Subject: Residential Property

Question 1

Will the costs of land, buildings, fees, property taxes, transfer duties etc. be allocated or apportioned according to floor area of the principal residence and the rental portion?

Answer

Yes. The cost of buildings, fees and property taxes (specifically council rates and land tax) will be apportioned according to the floor area of the principal residence and the rental portion. In this case the rental apartment will comprise 30% of the total floor area of house (principle residence and rental flat), and accordingly these costs are deductible on a pro-rata basis.

You are also entitled to a deduction for interest to the extent to which you use part of a dwelling to derive rental income. In the current scenario, this equates to Z%.

If however, it can be shown that the value of the rental portion of the dwelling is greater or lesser than Z%, then, the extent to which the above costs are apportioned should be adjusted accordingly.

The same general rule applies to land and stamp duty, except that it should be noted that these costs are not deductible, being of a capital nature.

Question 2

Will any of the loan interest costs be tax deductible while the house is being constructed? If so, can the benefit be received as a tax deduction with the taxpayer's monthly PAYE salary, if not, when can this cost be claimed?

Answer

Yes. You can claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for rates and other holding costs incurred on a vacant block of land held for future income producing purposes however the deduction should be claimed in your annual income tax return for the relevant year of income.

Question 3

Can I finance the cost of construction of the rental property solely with the debt and use the equity to finance the principle residence portion? If not can I use the equity as collateral for a loan and finance the whole development, i.e. Land, principle residence and rental flat with loan?

Answer

The Commissioner can only provide a private ruling in response to a valid request. For the following reason we cannot provide you with a private ruling in respect of this question. Your application in respect of this question does not set out a scheme or arrangement to which a relevant provision of the law might apply.

Question 4

What are the GST consequences of the taxpayer building and selling a residential property at the proposed address?

Answer

See reasons for decision.

Question 5

Will Capital Gains Tax be payable on the sale of the property? If so how will it be calculated in relation to the principal residence portion and the rental generating portion of the property?

Answer

The Commissioner has declined to rule on this question.

This ruling applies for the following periods:

Year ended 30 June 2014

Year ended 20 June 2015

The scheme commences on:

1 July 2013

Relevant facts and circumstances

1. You sell (or intend to sell) your currently owned principal place of residence;

2. You acquire vacant green title block of land (Property). The Property to be acquired will be registered in the names of your partner (X%) and yourself (Y%) as tenants -in-common;

3. Depending on actual sale and purchase dates of the abovementioned properties, there may be a period where you own both properties;

4. Cash to be deposited in bank (yet to be determined) to be used with land as collateral - for a new bank loan to be utilised for the purchase price and to build a house on the land;

5. The house will be built and will take approximately 18-24 months to complete;

6. The build will be completed in two phases with a proposed rental generating self contained apartment being completed first. The rental apartment will comprise Z% of the total floor area of house.

7. You envisage that the apartment will start to generate a rental income a specific number of months after acquisition of the land.

8. You intend to retain ownership of the property indefinitely with the apartment to continue to generate rental income;

9. The rental generating apartment and the principle residence will be connected and on the same property title.

10. You do not carry on an enterprise of property development or property investment; and

11. You are not registered for GST.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 118-190

A New Tax System (Goods and Services Tax) Act 1999 Division 9

A New Tax System (Goods and Services Tax) Act 1999 Division 11

A New Tax System (Goods and Services Tax) Act 1999 Division 19

A New Tax System (Goods and Services Tax) Act 1999 Division 40

A New Tax System (Goods and Services Tax) Act 1999 Division 129

Schedule 1 of the Tax Administration Act 1953 section 359-35

Reasons for decision

Question 1

Summary

Yes. The cost of land, buildings, transfer duties, fees/property taxes (namely local council, water and sewage rates, land taxes and emergency services levies) and interest will be apportioned according to the floor area of the principal residence and the rental portion. In this case the rental apartment will comprise Z% of the total floor area of the house (principle residence and rental flat).

Detailed reasoning

In your ruling request you have advised us that the rental apartment will comprise Z% of the total floor area of the house (principle residence and rental flat). Taxation Ruling IT 2167 stipulates that as a "general approach apportionment should be made on a floor area basis, i.e. by reference to the floor area of the residence to which the tenant/lodger has sole occupancy". Accordingly this will entitle you to claim Z% of your total outgoings which are incurred in gaining or producing assessable income. However you cannot deduct any loss or outgoing to the extent that it is a loss or outgoing of a capital nature.

Fees and property taxes (namely local council, water and sewage rates, land taxes and emergency services levies) will be apportioned according to the floor area of the principal residence and the rental portion. In this case the rental flat comprises Z% of the total floor area of the house. This apportionment is relevant for the purposes of deductibility of the costs of local council, water and sewage rates, land taxes and emergency services levies.

Taxation Determination TD 1999/66 also provides that you are entitled to a deduction for interest to the extent to which you use part of the dwelling to derive rental income (paragraph 2, TD 1999/66). If you use part of a dwelling for income producing purposes, an interest deduction is normally allowed on the basis of the percentage of the floor area used for income producing purposes. (paragraph 3, TD 1999/66). Accordingly, Z% of the interest is deductible unless you can show that the value of the rental property as a proportion of the entire dwelling is greater or less than Z%.

In respect of the outgoings of a capital nature such as the land, building and transfer duties, these costs can be apportioned according to floor area because the cost base of the land, as per section 110-25(2)(a) of the Income Tax Assessment Act 1997 (ITAA 1997), is the total of the money you paid in respect of acquiring it. The cost incurred in respect of land, building and transfer duties can also generally be apportioned according to floor space.

Question 2

Summary

Yes. You can claim a deduction under section 8-1 of the ITAA 1997 for rates and other holding costs incurred on a vacant block of land held for future income producing purposes when you lodge your annual income tax return.

Detailed reasoning

Where a taxpayer is not carrying on a business, an interest expense is deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in gaining or producing assessable income and the expense is not of a capital, private or domestic nature.

The character of interest on a loan is generally ascertained by reference to the purpose of the loan. Therefore, if a loan is used to purchase property from which income is to be derived, the interest paid on the loan is generally deductible.

You are entitled to a deduction, under section 8-1 of the ITAA 1997, for the interest on a loan, where the proceeds of the loan are used to build the rental portion of your purchase, as the dwelling is being used to generate rental 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 in considering the decision of the High Court in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's case) 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.

These expenses are incurred with regard to property to be used solely for income producing purposes. The expenses are not considered to have been incurred at a point 'too soon' before the commencement of the income producing activity.

ATO ID 2001/479 states that the length of time between purchase of the property and commencement of construction is not considered to be so long that the necessary connection between the outgoings and the assessable income is lost. You intend to complete construction within a specified amount of months of the purchase of the land. This is precisely the time frame stipulated in ATO ID 2001/479.

In these circumstances, you are entitled to a deduction for loan interest costs under section 8-1 of the ITAA 1997 in your annual income tax return for the relevant year of income.

Question 3

Summary

The Commissioner can only provide a private ruling in response to a valid request. For the following reason we cannot provide you with a private ruling in respect of this question. Your application in respect of this question does not set out a scheme or arrangement to which a relevant provision of the law might apply.

Detailed reasoning

In your application you have asked us to rule on whether you can finance the cost for construction of the rental property solely with the debt and use the equity to finance the principle residence portion. We are unable to provide you with a ruling on this issue because it is not a tax issue or an issue that requires the application of a tax law. We can only provide you with a private ruling on an identified relevant tax provision and how it applies to your circumstances. The relevant provision must be capable of applying to you personally in order for you to be able to obtain a private ruling on it.

As this question in your application does not set out a scheme or arrangement to which a relevant provision of law has been identified, the question is considered invalid and a private ruling cannot be issued on it.

Question 4

Summary

See detailed reasoning below.

Detailed reasoning

GST Payable.

Under section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), you must pay the GST payable on any taxable supplies that you make.

Section 9-5 of the GST Act provides you make a taxable supply if:

(a) you make the supply for *consideration,

(b) the supply is made in the course or furtherance of an *enterprise you *carry on,

(c) the supply is *connected with Australia, and

(d) you are *registered or *required to be registered for GST.

However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed.

The construction, and subsequent sale, of your private residence will not be done in the course or furtherance of an enterprise that you carry on. Therefore, there will be no GST consequences in relation to this portion of the dwelling.

However, part of the dwelling will be used for residential rental.

As defined in subsection 9-20(1) of the GST Act, an enterprise includes an activity, or a series of activities, done:

· in the form of a business, or

· in the form of an adventure or concern in the nature of trade, or

· on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property;

Your supply of the rental property by way of lease will constitute a leasing enterprise in accordance with the above definition. Under subsection 40-35(1) of the GST Act, your supply of the rental property by way of lease will be an input taxed supply.

You have also indicated that you may sell both portions of the dwelling at a later date.

Under subsection 40-65(1) of the GST Act, a sale of real property is input taxed, but only to the extent that the property is residential premises to be used predominantly for residential accommodation. However, under subsection 40-65(2), the sale is not input taxed to the extent that the residential premises are commercial residential premises or new residential premises, other than those used for residential accommodation before 2 December 1998.

New residential premises is defined in subsection 40-75(1) of the GST Act. The definition includes residential premises that have not previously been sold as residential premises.

However, under paragraph 40-75(2)(a) of the GST Act, premises are not new residential premises if, for a period of at least five years since the premises first became residential premises, the premises have only been used for making input taxed supplies by way of lease, hire or licence.

Goods and Services Tax Ruling 2003/3: when is a sale of real property a sale of new residential premises? (GSTR 2003/3) provides guidance in relation to the five year requirement. It states in paragraph 91;

We consider the five year period must be a continuous period. A continuous period is not broken by short periods between tenancies where the premises are actively marketed for rent following the departure by a previous tenant.

GSTR 2003/3 also states at paragraph 92;

However a continuous period would not include periods when the premises are used for a private purpose or left vacant with no attempt to lease, hire or licence.

Therefore, if you sell the rental premises before they have been used for making input taxed supplies by way of lease, hire or licence, for a period of at least five years since the premises first became residential premises, the sale proceeds will be taxable and included in your current GST turnover, which will exceed the registration turnover threshold. Consequently, you will be required to be registered for GST. As you will satisfy all requirements of section 9-5 of the GST Act, your supply of the rental property will be a taxable supply.

Entitlement to input tax credits.

Section 11-20 of the GST Act provides that you are entitled to the input tax credit for any creditable acquisition that you make.

Subsections 11-15 (1) and (2) of the GST Act provides that:

(1) You acquire a thing for a creditable purpose to the extent that you acquire it in *carrying on your *enterprise.

(2) However, you do not acquire the thing for a creditable purpose to the extent that:

(a) the acquisition relates to making supplies that would be *input taxed; or

(b) the acquisition is of a private or domestic nature.

Part of the house will be used for your private residence. The rental portion will be used to make input taxed supplies. Therefore, you are not entitled to any input tax credits on the construction of either part of the house.

Adjustments for change in extent of creditable purpose

As previously stated, if you sell the rental part of the premises before it has been used for making input taxed supplies by way of lease, hire or licence, for a period of at least five years since the premises first became residential premises, your supply of the rental portion will be a taxable supply.

In this circumstance, you may be entitled to a decreasing adjustment (by way of an increase in your entitlement to input tax credits) under Division 129 of the GST Act.

Question 5

Summary

Under certain circumstances, the Commissioner may decline to make a private ruling. The Commissioner has decided to decline to make a private ruling in this case.

Detailed reasoning

The Commissioner may decline (refuse) to make a private ruling (see, section 359-35 of Schedule 1 of the Tax Administration Act 1953 (TAA)) where:

· Making the ruling would prejudice or unduly restrict the administration of a taxation law (paragraph 359-35(2)(a)).

· The matter sought to be ruled on is already being, or has been considered by the Commissioner for the taxpayer (paragraph 359-35(2)(b)).

· The matter sought to be ruled is on how the Commissioner would exercise a power under a relevant provision and the Commissioner decides to exercise the power (or not to) (subsection 359-35(3)).

· The Commissioner has asked for further information and the applicant has not provided that within a reasonable time (see, subsection 357-105(2) of Schedule 1 to the TAA; see Requesting additional information for further information).

· The Commissioner considers that correctly making a private or oral ruling would depend on making an assumption about a future event or other matter (see, paragraph 357-110(1)(a) of Schedule 1 to the TAA; see Making assumptions for further information).

· The Commissioner proposes to use third party or other information which is material to the outcome of the ruling but can not disclose this information to the applicant because such action would breach the tax secrecy provisions, privacy legislation or the confidentiality of the person providing the information. It is expected that this circumstance would be very rare (see, section 357-120 of Schedule 1 to the TAA; see Using third party information for further information).

In your case you have stated that you intend to retain ownership of the property indefinitely with the apartment to continue to generate rental income. As such, according to section 359-35(2)(a) of Schedule 1 of the TAA you are not seriously considering the scheme i.e. sale of the property, and, therefore the Commissioner may decline to rule on the basis that making the ruling might prejudice or unduly restrict the administration of tax law.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).