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Ruling

Subject: Rental property deductions

Question 1

Are you each entitled to a deduction for your share of the interest expenses incurred on a loan used to purchase a vacant block of land prior to engagement of your builder?

Answer

No.

Question 2

Are you each entitled to a deduction for your share of the interest expenses incurred on a loan used to purchase a vacant block of land after engagement of your builder?

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 and circumstances

You purchased a block of land in 20XX.

You each hold an equal share in the block of land.

The block of land was financed by an interest only loan in joint names.

You have incurred interest expenses against this loan.

You state that you have always intended to build a rental property on the land however you needed to be in a better financial position before you could do so.

You engaged a builder in 20XX.

You state that a rental property will be built on the block of land during the 20XX-XX financial year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

The interest incurred on the vacant block of land prior to engagement of your builder is not deductible as no continuing efforts were made in pursuit of gaining assessable income from the property.

However, your continuing efforts were revived upon engagement of your builder. The interest incurred after this point in time is therefore deductible so long as your intention remains the same.

Detailed reasoning

Prior to engagement of a builder

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.

It is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. Taxation Ruling TR 2004/4 considers the decision in Steele v. Deputy Commissioner of Taxation (1999) 197 CLR459 (Steele's case) and 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.

TR 2004/4 states that, in considering the final of the above conditions, a test of 'continuing efforts' would need to be set within the context of the normal time frames of the relevant industry. However, if a venture becomes truly dormant and the holding of the asset is passive, relevant interest will not be deductible even if there is an intention to revive that venture some time in the future.

In your situation, your intention in purchasing the land has always been for income producing purposes. However, the length of time between the purchase of the land and engagement of a builder is considered to be so long that the venture had become dormant. The reason for the delay in constructing the property was your financial position and not any factors intrinsic to the property development itself. It is not considered that you made continuing efforts in respect of constructing the rental property on the land. Accordingly, you are not entitled to a deduction for the interest expenditure you incurred in relation to your vacant land prior to engagement of a builder.

Upon engagement of your builder, we believe that your continuing efforts to gain assessable income from the property were revived. You will be able to commence building shortly after this time. Therefore, any interest expenditure incurred subsequent to engagement of your builder will be deductible under section 8-1 of the ITAA 1997.

Taxation Ruling TR 93/32 states that income or loss from a rental property must be shared according to the legal interest of the owners. As you hold an equal interest in the land, the expenses you have incurred must therefore be apportioned equally between you.

Note

It is important to note however, the interest will only be deductible as long as your intention to hold the property for income producing purposes remains the same. If your intention changes and you no longer hold the property for rental income purposes, you cannot claim a deduction for the interest after your intention changes.