Edited version of private ruling

Authorisation Number: 1011801576048

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Ruling

Subject: Deduction - interest

Question 1

Are you and your spouse entitled to a deduction for a portion of the interest incurred on a loan taken out to purchase an investment property for the period time you were living in town A?  

Answer: No.

Question 2

Are you and your spouse entitled to a deduction for a portion of the interest incurred on a loan taken out to pay for the cost in relation to work undertaken on your investment property when you were living in town A?  

Answer: No.

Question 3

Are you and your spouse entitled to a deduction for a portion of the holding costs incurred on an investment property for the period of time you were living in town A?

Answer: No.

Question 4

Are you and your spouse entitled to a deduction for a portion of the interest incurred on a loan taken out to purchase an investment property for the period time you were living in town B?  

Answer: Yes.

Question 5

Are you and your spouse entitled to a deduction for a portion of the interest incurred on a loan taken out to pay for the cost in relation to work undertaken on your investment property for the period time you were living in town B?  

Answer: Yes.

Question 6

Are you and your spouse entitled to a deduction for a portion of the holding costs incurred on a property for the period time you were living in town B?

Answer: Yes.

This ruling applies for the following periods:

Year ended 30 June 2007

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commenced on:

1 July 2006

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· a private ruling request

· bank statements

· a development plan for the property

· tax invoice for the purchase of the property

· a number of photographs of the property.

You and your spouse were employed and residing in town A

You and your spouse jointly purchasing the property located in town B.

The property has a number of bedrooms and is a timber frame house with asbestos sheeting on the external walls and roofing.

The property was built in the late 1950s.

Your intention was to rent the property as an investment property and to re-develop the property at a later date for investment purposes.

To finance the purchase of the property you borrowed funds from a financial institution.

No building or inspection report was undertaken before the property was purchased.

The property had a number of defects and could not be rented.

You and your spouse obtained a number of quotes and advice to undertake the work to the property.

You borrowed additional funds to undertake the work at the time of purchasing the property.

You did not engage anyone to undertaken the repairs to the property.

You and your spouse first inspected the property with a real estate agent a number months after it was purchased and discovered the property had been vandalised and items in the property were stolen.

You and your spouse did not advertise the property for rent after meeting the real estate agent as the property could not be rented.

You and your spouse returned to town B a number of years after purchasing the property to carry out the required work to the property.

You visited the property a number of times to undertake work to the property.

You engaged a number of tradesmen to undertake work to the property.

The loans to purchase and undertake the work to the property have been repaid.

You engaged a surveyor who submitted a concept plan for the subdivision of the property recently.

You intend to install a number of appliances in the property before it is made available for rent.

You incurred a number of costs to hold the property.

The property has not been rented since it was purchased.

There is no private or domestic use of the property after purchase.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1.

Reasons for 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 nature, or relate to the earning of exempt income.

The principles governing deductibility depend upon satisfying, or being able to show, that the expense has sufficient connection with the operations or activities which directly gain or produce a taxpayer's assessable income. In other words, the interest and other deductions must be incurred in relation to a property which is held for income-producing purposes. Whether such a connection exists is a question of fact to be determined by reference to all the facts of the particular case.

Taxation Ruling TR 2004/4 considers deductions for interest incurred prior to the commencement of income earning activities and the implications of the decision of the High Court in Steele v. Federal Commissioner of Taxation (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steele's case).

In Steele's case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. It follows from Steele's Case that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income if: 

· 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.

While Steele's case deals with the issue of interest, the principles can be applied to other types of expenditure including local council, water costs and insurance payments.

Interest expense from the date of purchase until you returned to town B

You and your spouse purchased an investment property with the intention to rent the existing dwelling on the property and to re-develop the property at a later date.

Even though a property may be being held with the intention of producing income in the future, the expenses of holding it may not be deductible. In Inglis v FC of T 80 ATC 4001; (1980) 10 ATR 493 (Inglis case), a couple had been conducting a primary production business on a property. When rural conditions deteriorated both the husband and the wife took jobs away from the property. In the years that the court considered, no farming activity took place and no income was earned from the property. The Federal Court found that, even though the taxpayers intended to return to the primary production business in the future, no deduction could be claimed for the holding costs and depreciation expenses associated with the property. The court said, at ATC 4004; ATR 496:

'In the present case, the expenditure for which deductions were claimed may have been incidental or relevant to the preservation of Lammermuir as a pastoral property. But expenditure on or in connection with Lammermuir does not become expenditure incurred in gaining or producing future assessable income merely because the taxpayer intends in the future to use Lammermuir to produce assessable income. If a capital asset is not being used to produce assessable income, expenditure in merely preserving the asset until it is so used is not deductible. Rather, being expenditure upon a capital asset not employed in producing income, it has the character of a capital outgoing.'

You have made reference to Ormiston v. FC of T 2005 ATC 2340 (Ormiston's case) to support allowing a deduction for the interest, local council rates, water and sewerage rates and emergency service levies.

In Ormiston's case the taxpayer purchased an investment property in July 1998 as a long term investment to provide rental income and increase in value. The taxpayer borrowed funds from the Commonwealth Bank of Australia to cover the purchase price, stamp duty, conveyancing costs and materials to make repairs and improvements. The taxpayer arranged an inspection by two local real estate agents shortly after taking possession of the investment property for an estimate of the potential rent the property could generate. The property required additional improvements to generate additional rental income. Initially, the taxpayer expected the work to take up to twelve months. Soon after commencing work on the investment property, he decided that it would be prudent to restump the house. This delayed work on other areas of the investment property and resulted in more work and time than initially contemplated in repairing lath and plaster internal walls and external walls. Initially he worked on the investment property most weekends and some evenings. The taxpayer encountered some personal problems and as a result of these personal problems, a change of employment and reduced enthusiasm for the prolonged renovations, little was accomplished during the 2001 and 2002 years.

A deduction for interest and other expenses were allowed for a property that was still not income producing after nearly five years. However, it was shown that the taxpayer had over the whole period made continued efforts in pursuit of the property being income producing.

The circumstances of your case have some relevance to the Ormiston's case in that you purchased the property with the intention of earning rental income. However, your case can be distinguished from both Steele's case and Ormiston's case in that at the time of purchasing the property you were advised the property could not be rented safely as the property required repairs to the electrical wiring and the asbestos sheeting. It is acknowledge advice and quotes were sought in regards to the repairs to the property and a loan was taken out to finance the required repairs.

However, during the period from the date of purchase of the property until you returned to town B, no continuing effort were made to undertake the required repairs with the aim of producing assessable income as during this time you and your spouse had only visited the property to undertake an inspection and to meet with an agent at the property. Where in Ormiston's case the taxpayer worked on the investment property most weekends and some evenings during the early years of holding the property and there were continuous effort being made over the period holding the property in pursuit of the property being income producing.

We acknowledge you and your spouse's were employed in town A during this period may have effected your commitment to undertake the necessary work to the property. However, your circumstances during this period until you returned to live in town B would indicate there have been insufficient or no continuing efforts made to prepare the property in town B to earn assessable income. As noted in the reasons given by Callinan J in the Inglis case:

if the venture becomes truly dormant and the holding of the assets is passive, relevant interest will not be deductible even if there is an intention to revive that venture some time in the future.

The courts require evidence of commitment to a future income producing activity before deductions for expenses related to that activity will be allowed. Therefore your interest expenses and holding costs incurred during this period until you returned to live in town B are not an allowable deduction under section 8-1 of the ITAA 1997.

Interest expense after you returned to reside in town B

You returned to town B after living in town A for a number of years at which time you had undertaken work to upgrade the property to make it available for rent at a later date. Your intention is to use the property for income producing purposes. In these circumstances, the interest expenses are not considered to be preliminary or incurred at a point too soon before the commencement of the income producing activity. There is no private or domestic use of the property.

The length of time between commencement of the work on the property and the property being rented is not considered to have been so long that the necessary connection between the interest outgoings and the assessable income is lost.

Accordingly, as you jointly own the property with your spouse, you and your spouse are each entitled to claim a deduction under section 8-1 of the ITAA 1997 for half of the interest expense in relation to the loans to purchase and to carry out the work to the property from the time you returned to reside town B until the loan was repaid.

Holding cost for the period after you returned to reside in town B

For the same reasons as discussed above with respect to interest during the period after you returned to town B to live until the property is made available for rented, any holding costs are not considered to have been incurred at a point 'too soon' before the commencement of the income producing activity.

Therefore, as you jointly own the property with your spouse, you and your spouse are each entitled to claim a deduction for half of the holding costs incurred under section 8-1 of the ITAA 1997.