Edited version of private ruling

Authorisation Number: 1011850707482

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Ruling

Subject: Rental deductions - Interest

Question and answer

Are you entitled to a deduction for your portion of the interest incurred on a loan to fund the purchase of an investment house and land package when the borrowed funds are also used to pay the interest charges for the land purchase?

Yes

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

You and your spouse are purchasing a house and land package.

Both your names will be on the title as joint tenants.

You will borrow funds to purchase the land, construct the house plus other costs associated with the construction.

The loan you take out will also be used to pay interest charges on the land purchase and to pay for progress payments while the house is being constructed.

Your contract states the house will be built within six months of the date you purchased the land.

The house will be an investment property and will be rented as soon as practicable after completion at market rates.

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.

Taxation Ruling TR 95/25 Income tax: Deduction for interest under section 8-1 of the Income Tax Assessment Act 1997 discusses deductions for interest under section 8-1 of the ITAA 1997. To establish that there is a sufficient connection between incurring an interest expense and the gaining or producing of assessable income, regard must be given to all the circumstances including the use to which the borrowed funds are put.

The interest expense must have a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be 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. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest will be deductible to the extent that the funds are used to produce assessable income.

In Steele v. FC of T (1999) 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 Steeles 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 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

You will be incurring interest expenses on a loan for the purchase of land and construction of a rental property. The borrowed funds will be used to pay for interest charges on the land purchase and to pay progress payments on the construction of the house which is expected to take approximately six months. In these circumstances the interest incurred on the loan is not considered preliminary or to have been incurred too soon as it is incurred on funds borrowed for the sole purpose of producing income.

The funds you are borrowing are not being used for any private or domestic purpose; they are being borrowed to build an income producing property.

The length of time between the purchase of the land, the intended commencement of construction and the availability of the property for rent is not considered to be so long that the necessary connection between the outgoings and the assessable income is lost.

Conclusion

You are entitled to a deduction under section 8-1 of the ITAA 1997 for interest incurred on funds borrowed to finance the purchase of vacant land and construct a house which will be used for future income producing purposes.