Edited version of private advice

Authorisation Number: 1052253573958

Date of advice: 20 June 2024

Ruling

Subject: Property with building defects

Question 1

Will the Commissioner extend the exceptional circumstances exemption relating to vacant land and allow you to continue to deduct rental property expenses for your apartment?

Answer

Yes.

Question 2

Are the financial assistance amounts received from the State Government treated as a reduction to the cost base of the apartment?

Answer

No.

Question 3

If the answer to question 2 is no, are the financial assistance amounts received from the State Government treated as assessable income?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

The scheme commenced on:

XX/XX/20XX

Relevant facts and circumstances

On XX 20XX, you acquired the Apartment. The Apartment is in the Building.

In 20XX, you leased the Apartment out.

On XX XX 20XX, the State Government deemed the Building uninhabitable due to the structural defects. You were forced to terminate the lease entered in 20XX. The Building remains uninhabitable to this day. The Apartment to date has not been rented and no rental income was derived from the time the Building was deemed uninhabitable.

From the date the Apartment was deemed uninhabitable, you have incurred interest on your mortgage and body corporate administrative fees or levies that were raised for a deductible purpose.

You have also received financial assistance from the State Government which was offered to eligible owners of apartments in the Building. A condition of the financial assistance is that in the event that you receive proceed related to the loss of rent (as a result of legal proceedings, an insurance claim or by settlement agreement) you must reimburse the State Government.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 26-102

Income Tax Assessment Act 1997 Subsection 26-102(4)

Income Tax Assessment Act 1997 Subsection 26-102(6)

Income Tax Assessment Act 1997 Subsection 59-30

Reasons for decision

Question 1

Will the Commissioner extend the exceptional circumstances exemption relating to vacant land and allow you to continue to deduct rental property expenses for your Apartment?

Summary

The Commissioner will extend the exceptional circumstances exemption relating to vacant land and allow you to continue to deduct rental property expenses for your apartment.

Detailed reasoning

Subsection 26-102(1) of the Income Tax Assessment Act 1997 (ITAA 1997) limits the deduction on the amounts relating to holding land if at that time of incurring the loss or outgoing there is no substantial and permanent structure in use or available for use on the land.

This means that from the introduction of the legislation on 1 July 2019, income tax deductions to taxpayers will be denied for losses and outgoings incurred in holding vacant land, regardless of when acquired, to the extent the land is not at the time of incurring the expense or outgoing:

•         used or held available for use by the entity in the course of carrying on a business for the purposes of gaining or producing assessable income; or

•         used or held available for use in carrying on a business by:

o   an affiliate, spouse or child of the taxpayer; or

o   an entity that is connected with the taxpayer or of which the taxpayer is an affiliate.

Subsection 26-102(4) of the ITAA 1997 states that residential premises that you construct or substantially renovate will be treated as not being a substantial and permanent structure until they can lawfully be occupied and are leased, hired or licensed (or available for lease, hire or licence).

Subsection 26-102(6) of the ITAA 1997 allows an exception where structures have been affected by natural disasters or other exceptional circumstances.

The exemption may apply where an exceptional circumstance outside your control occurs that results in the substantial and permanent structure no longer being on your land or the structure being disregarded. That is, there must have been a substantial and permanent structure on the land prior to the time that the exceptional circumstance occurred. If the substantial and permanent structure was residential premises, then the residence must have been lawfully able to be occupied and have been either leased or available for lease prior to the exceptional circumstance.

The Commissioner is of the view that your circumstances are exceptional circumstances as per section 26-102 of the ITAA 1997 and therefore you can deduct the losses or outgoings incurred in holding the apartment pursuant to section 8-1 of the ITAA 1997. The losses or outgoings that can be deducted are those that 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. The portion of the mortgage payment applied to the principal is not tax deductible because this part of the payment reduces your outstanding loan balance dollar for dollar. In other words, there is no "expense" within a principal payment.

With respect to body corporate fees, not all body corporate fees are deductible under s 8-1 of the ITAA 1997. The deductibility of body corporate fees will depend on the purpose to which the fees are being applied. The Building's body corporate has raised several different levies, including some to take legal action. TR 2015/3 Income tax: matters relating to strata title bodies constituted under strata title legislation provides that in determining what body corporate fees are deductible, a 'look-through approach' should be adopted. That is, individual owners can claim the deduction if the body corporate is raising the money for a deductible purpose pursuant to s8-1 of the ITAA 1997. As a general rule, deductible purposes are administrative fees.

Further information about deductions for vacant land can be found by searching 'QC60628' on ato.gov.au

Question 2

Are the financial assistance amounts received from the State Government treated as a reduction to the cost base of the Apartment?

Summary

The financial assistance amounts received from the State Government are not treated as a reduction to the cost base of the unit.

Detailed reasoning

The receipt of any compensation takes on the nature of the money it replaces, following the principle in

Dixon v FCT. Therefore any compensation that is received by an owner in order to compensate them for their lost rental income, takes on the character of that lost rental income.

The financial assistance amounts received from the State Government are not treated as a reduction to the cost base of the Apartment and are instead considered to be rental or income in nature.

Question 3

If the answer to question 2 is no, are the financial assistance amounts received from the State Government treated as assessable income?

Summary

The financial assistance amount received from the State Government are treated as assessable income.

Detailed reasoning

The receipt of any bulk compensation takes on the nature of the money it replaces, following the principle in

Dixon v FCT. Therefore any compensation that is received by an owner in order to compensate them for their lost rental income, takes on the character of that lost rental income.

Any other payment for pain, loss or suffering is not considered income in nature and is therefore not taxed. If an owner, after receiving an out-of-court settlement that relates to rent, must then pay back monies to the State Government, then the money they received from the NSW government was income that they were previously entitled to but are now no longer entitled to and must be repaid.

Money that must be contractually or legally repaid in a later income year, when an obligation to pay arises, is not considered assessable income as per section 59-30 of the ITAA 1997. This is the case even if no obligation to repay existed at the time the money was derived.

Section 59-30 of the ITAA 1997 is designed to cover amounts that are not usually deductible under other deduction provisions within tax law, such as section 8-1 of the ITAA 1997. As it is not an amount incurred in producing assessable income but rather an amount where an obligation to repay has arisen at a later date, it is covered by section 59-30 of the ITAA 1997 and not section 8-1 of the ITAA 1997.

As per section 170(10AA) of the Income Tax Assessment Act 1936 (ITAA 1936), a taxpayer has an unlimited amendment period to amend their tax return if the amendment is in relation to a payment covered by section 59-30 of the ITAA 1997. A payment covered by section 59-30 of the ITAA 1997 is one that must and is repaid, and cannot be deducted.

If you do indeed amend your tax return to exclude the rental repayments you would make to the State Government, any amounts received from the settlement that replace those repaid amounts will carry with them a rental income nature. Hence they will be assessable in the income year that they are derived.

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