Edited version of private ruling

Authorisation Number: 1011643491131

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Ruling

Subject: Rental property - interest

1. Are you entitled to a deduction for the interest on the loan from the date of purchase of a block of land until you contracted a builder to build your house?

No.

2. Are you entitled to a deduction for the interest on the loan from the date you contracted a builder to construct your house until the time you placed the house for sale on the market?

Yes.

3. Are you entitled to a deduction for the interest on the loan during the period the house was on the market?

No.

4. Will you be eligible to include amounts of interest and rates not claimable as deductions in the cost base of your investment property?

Yes.

This ruling applies for the following period

Year ending 30 June 2008

Year ending 30 June 2009

Year ending 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 July 2007

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 and your spouse purchased a block of land for the sole purpose of building an investment property.

After purchasing the investment block, you also purchased another block of land to build a new family home.

You own your own home that you are residing in which you were endeavouring to sell to fund the construction of your new residence.

Due to economic conditions you were unable to sell your residence which caused financial hardship resulting in you not building on the investment block of land.

At the time of nearing completion of your new residence, you gained a new job and began your training course. Your spouse completed the interior of the new home and established the gardens, resulting in a further delay in the building on the investment block of land.

Shortly after graduating from your new employment, you suffered an injury at which time you enquired at the local bank for a loan to build on the investment block of land.

You advised building on the block of land began in 2008 with completion of the house being in 2009.

You used a complete package building which included all floor and window coverings and painting which meant that tenants could move in as soon as possible.

You sold the family car to establish the waterwise landscaping on your rental property.

During the process, you could not sell the property as property values had fallen due to economic conditions. Your new place of residence was eventually sold, resulting in $X less than the anticipated selling price.

The rental property was placed on the market in 2010 with a real estate agent on a three month contract.

This was to alleviate your current financial hardship.

You used a redraw facility to make repayments on the loan.

The property was subsequently withdrawn from the market at the end of the three month real estate contract, in 2010. The property was then available for rent.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 110-25(1)

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

Income Tax Assessment Act 1997 Section 110-45(1B).

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

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 in nature.

Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income.

The Commissioner of Taxation has issued Taxation Ruling TR 2004/4 to provide guidance on when interest on a loan used to purchase land on which a person intends to build a rental property would be deductible.

TR 2004/4 states that it is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. The ruling concludes that interest 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.

Given regard to your whole circumstances, including the period of time you anticipate holding your investment property, the lack of building plans and engagement of a builder, the interest expenses relating to the vacant land is not considered to be incurred with regard to a property to be used for income producing purposes.

It is not considered that you have made continuing efforts in respect of constructing the rental house on the land. The length of time between purchase of the property and building contract date is considered to be so long that the necessary connection between the outgoings and the assessable income is lost and are incurred at a point 'too soon' before the commencement of the income producing activity.

Accordingly, you are not entitled to a deduction for the interest you incurred in relation to your vacant land for the period up to when you signed a building contract.

However, you are entitled to a deduction for the interest you incurred from when you signed the building contract until the house was placed on the market.

It is a requirement that there be some evidence of commitment to a future income producing activity before deductions for expenses related to that activity will be allowed. In your case, you decided to place the rental property on the market for a period of three months and therefore are not entitled to a deduction for interest for this period of time.

In summary, you are entitled to a deduction for interest for the period from when you signed a contract for the construction of your rental property until when you placed the property on the market for sale. You are also entitled to interest from when the property was available for rent or rented after the three month contract with the real estate agent for sale of the property expired.

However, you are not entitled to a deduction for interest for the period prior to engaging the builder as it is considered that you did not make sufficient continuing efforts towards building the property. Nor are you entitled to an interest deduction for the period after construction where the property was for sale and not available for rent.

Capital gains tax

The cost base of a capital gains tax (CGT) asset is generally the cost of the asset when you bought it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset.

The cost base of a CGT asset is made up of five elements. The third element of the cost base is made up of the non-capital costs of ownership. These costs include, but are not restricted to:

· interest on money you borrowed to acquire the asset

· costs of maintaining, repairing or insuring it

· rates or land tax, if the asset is land

· interest on money you borrowed to refinance the money you borrowed to acquire the asset, and

· interest on money you borrowed to finance the capital expenditure you incurred to increase the assets value.

These costs cannot be included in the cost base of a CGT asset when you have claimed a deduction for them in any income year, or omitted to claim a deduction, but can still claim it by amending your income tax return.

In your case, you obtained a loan in order to construct a dwelling on land that you owned for the purpose of renting it out. You have incurred interest in relation to these borrowings.

You will be able to include interest, and other associated costs of owning the asset, in the cost base of the investment property to the extent that you have not claimed a deduction for those costs, or can claim deductions for them.