Edited version of your private ruling

Authorisation Number: 1012534451362

Ruling

Subject: expenses and outgoings after property available for rent

Question 1

Are your share of the cost of ownership expenses (not including interest expenses) incurred between cessation of rental and the date of sale of your rental property required to be capitalised?

Answer

Yes.

Question 2

Are you entitled to claim a deduction for your share of the interest associated with the balance of the property loan from when the property ceased to be income producing?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You owned a percentage of a rental property as co-owner with your former spouse.

The property was acquired in the 2009-10 financial year and rented for a period of time.

For a period the property was both vacant and on the market for sale.

The property was sold at the time of sale there were insufficient proceeds to pay out the loan. A loan for the remainder owing was secured against a second property also owned by you and your former spouse.

Consent Orders of the Family Court were entered into. These orders require your former spouse to sign over the right, title and interest in the second property to you. The orders also require you to take over the mortgage debts registered against this property.

The second property is still in the process of being transferred to you, however, you have taken over the responsibility for the loan remaining for the former rental property and have been making all the loan repayments for a period prior to the Consent Orders being made. At this stage, the loan has not yet been refinanced solely into your name.

During the period when the property was both vacant and on the market for sale you incurred cost of ownership expenses other than interest for the rental property.

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 8-1

Income Tax Assessment Act 1997 - section 110-25

Income Tax Assessment Act 1997 - subsection 110-25(4)

Reasons for decision

Summary

Cost of ownership expenses incurred while the property was both vacant and on the market for sale are required to be capitalised.

In your circumstances interest expenses, apportioned according to legal title of the investment property involved, including for the period the property was unavailable for rent and on the market for sale, are considered to be deductible as the nexus between the expense and the income earning activity has not been broken.

Detailed reasoning

Capital expenses

In your situation there were expenses which you incurred for the period between 1 July 2012 and when the property was sold in January 2013 which may be included under the third element of the capital gains tax cost base.

The third element of the cost base is the cost of ownership of an asset, provided the asset was acquired on or after 21 August 1991. A cost of ownership of an asset is any expenditure in connection with the continuing ownership of the asset. These costs include costs of maintaining, repairing and insuring an asset, rates and land tax.

Since you acquired the property after 20 August 1991, your share of the costs of owning the property such as rates, water costs and insurance for the period where the property was both vacant and on the market for sale may be added to the cost base of the property under subsection 110-25(4) of the ITAA 1997.

Interest expenses

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.

Interest expenses are generally deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in relation to funds used for an income producing purpose.

The Commissioner's view on whether interest deductions are allowable after the cessation of the relevant income producing activity is outlined in Taxation Ruling TR 2004/4.

TR 2004/4 considers the implications of the Full Federal Court decisions in Federal Commissioner of Taxation v. Brown 99 ATC 4600; (1999) 43 ATR 1 (Brown's case) and Federal Commissioner of Taxation v. Jones 2002 ATC 4135; (2002) 49 ATR 188 (Jones case).

In Brown's case, the taxpayer partners borrowed to acquire a delicatessen. After a number of years of trading, the business was sold at a loss. The proceeds of the disposal were made over to the bank but were insufficient to satisfy the liability fully. There was no entitlement under the relevant loan agreement to repay the loan prior to its term without prior agreement of the bank.

In Jones case, the taxpayer, together with her husband, borrowed money to fund a trucking and equipment hire business. After her husband's death, Mrs Jones sold the assets of the business. The proceeds (plus other amounts on hand) were insufficient to pay out the loan and she was unable to fully repay the loan.

Brown's case and Jones case accordingly demonstrate that the occasion of interest expenditure can be found in the relevant income earning activities even where those activities are now defunct and all the borrowings (or assets representing those funds) are lost.

Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities.

If the taxpayer:

• keeps the loan on foot for reasons unassociated with the former income earning activities; or

• makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred,

the nexus between the outgoings of interest and the relevant income earning activities will be broken.

In your case, you sold the property and the amount you received was not enough to extinguish the loan outstanding on the property. The remaining portion of the loan is a continuing liability to repay the loan when the income producing activity has ceased and is seen to be a burdensome legacy of the past, which suggests a continuing nexus between the former income producing activity and the interest incurred on the loan. Therefore, the loan is considered to be kept on foot for reasons directly related to the income earning activities and the nexus between the interest expense and the relevant income earning activity has not been broken. As a result, the interest expense is an allowable deduction under section 8-1 of the ITAA 1997.

However, if the loan is refinanced or extended for reasons unassociated with the former income activities or where at a later time you have the ability to repay the loan but choose not to, then the interest will no longer be deductible

Taxation Ruling TR 93/32 discusses the division of net income or loss between co-owners of a rental property. The ruling explains that the loss or income from a rental property must be shared according to the legal interest of the owners, except in those very limited circumstances where there is sufficient evidence to establish that the equitable (or beneficial) interest is different from the legal title.

In your circumstances your legal title for the period up until the date of the Family Court Consent Orders was XX. As such you are entitled to claim XY of the interest up to this date even though you have been making all the loan repayments since xx/xx/yy. For the period after the consent orders you are considered to have beneficial interest for the whole property and will be entitled to claim all of the interest expenses from the consent order date.

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