Edited version of private advice

Authorisation Number: 1052393745812

Date of advice: 08 May 2025

Ruling

Subject: Rental property - deductions

Question 1

Can you claim deduction for the interest expense that you incurred prior the derivation of the assessable income under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes. The interest expense on the funds borrowed for the property is deductible prior the derivation of the assessable income as it meets the criteria in paragraph 9 of Taxation Ruling TR 2004/4 Deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities (TR 2004/4).

Question 2

Can you claim deductions for council rates and water rates that you incurred prior the derivation of the assessable income under section 8-1 of the ITAA 1997?

Answer 2

Yes. You can claim local council rate, water rates as deductions because these expenses incurred in gaining or producing assessable income and they are not capital, private or domestic nature.

Question 3

Can you claim the transfer duty (stamp duty) and lease preparation fees on the transfer of the property under section 25-20 of the ITAA 1997?

Answer 3

Yes. You are entitled to a deduction for the transfer duty (stamp duty) as your property is subject for 99-year crown lease and you have used the property solely for the purpose of producing assessable income.

This ruling applies for the following period:

Year ended XX 20XX

The scheme commenced on:

XX 20XX

Relevant facts and circumstances

On XX 20XX, you purchased a rental property (the property).

The property is subject to a 99-year lease ending on XX 21XX.

The intention for the property was always to be used for income producing purpose.

In XX 20XX, you had done a rental appraisal and took out an investment loan with a bank to purchase the property.

On XX 20XX, X initially took out the property insurance policy under their name, and it was later transferred into your names.

On XX 20XX, the settlement of the property occurred.

Prior to you purchased, the property was liveable as the previous owner occupied for many years.

You intended get the property to a standard of rental requirements by minor renovation.

On 18 June 20XX, you paid transfer duty (stamp duty).

In XX 20XX, the renovation works was completed, you contacted with real estate agent and advertised the property for rent.

In XX 20XX, the property was listed as available for lease.

On XX 20XX, the tenant agreement was signed.

Before receiving rental income, you incurred interest expense, council rates and water rates.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-20

Income Tax Assessment Act 1997 section 26-102

Reasons for decision

Question 1

Can you claim deduction for the interest expense that you incurred prior the derivation of the assessable income?

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.

In general, interest expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature. The essential character of the expense is a question of fact to be determined by reference to all the circumstances.

TR 95/25 income tax: deductions for interest undersection 8-1 of the ITAA 1997 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, regard must be given to all the circumstances including the purpose of the borrowing and the use to which the borrowed funds are put. The interest incurred will generally be deductible to the extent that the borrowed funds are used to produce assessable income.

The Commissioner's view on whether interest expenses are deductible prior to the derivation of the assessable income, and the implications of the decision of the High Court in Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's case) are outlined in Taxation Ruling (TR) 2004/4.

Paragraph 9 of TR 2004/4 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.

For detailed information on this Tax Ruling 2004/4, please visit the Legal Database on the ATO website (ato.gov.au) and search for 'TR 2004/4'.

While the TR 2004/4 deals with the issue of the interest expense, the principles can be applied to other types of expenditure including property insurance, local council rates and water rates.

In your case, you took out an investment loan to purchase a property with the purpose of being a rental property. You undertook steps to rent the property out, including contacting the real estate agent, and renovating the property to the rental standard requirements.

Section 26-102 of the ITAA 1997 does not prevent you from claiming a deduction for the interest on the loan used prior receiving assessable income as the renovations undertaken were less than those outlined by the section. There is an existing liveable structure on the property, that underwent some repairs in preparation for renting.

As a result, you are eligible to claim deductions for the interest expenses that you incurred prior to the derivation of the assessable income.

Question 2

Can you claim deductions for council rates and water rates that you incurred prior the derivation of the assessable income?

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

Expense associated with holding the property such as local council rate, water rates can be claimed as deduction under section 8-1 of the ITAA 1997.

In your case, you purchased the property with the intention to produce assessable income and the property has been rented out. You incurred council rates and water rates prior to the derivation of the relevant income. Therefore, you can claim these expenses as a deduction under section 8-1 of the ITAA 1997.

Question 3

Can you claim the transfer duty (stamp duty) and lease preparation fees on the transfer of the property under section 25-20 of the ITAA 1997?

Detailed reasoning

Subsection 25-20(1) of the ITAA 1997 states:

You can deduct expenditure you incur for preparing, registering or stamping:

(a)          a lease of a property; or

(b)          an assignment

if you have used or will use the property solely for the purpose of producing assessable income.

It is necessary to determine whether the transfer duty has been incurred in leasing a property or in assigning a lease of property in accordance with subsection 25-20(1) of the ITAA 1997.

Although the term 'lease' is not defined in the taxation legislation, the general law requirement is that a lease must be granted for a definite period. A long-term lease is a 'lease' for the purposes of section 25-20, as it is for a determinate period of XX years.

In your case, your property is subjected to XX-year crown lease and its sole use is to produce assessable income. The tenancy agreement was signed on XX XX 20XX. Therefore, you can claim the deduction for the stamp duty expense and the lease preparation fees in the year it incurred under section 25-20 of the ITAA 1997.

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