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Ruling

Subject: land tax and rates

Question

Are you entitled to a deduction for your share of the land tax and rates for your rental property while it is being rebuilt?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts

You jointly own a house which you purchased several years ago.

You have never lived in the house and it has been tenanted since purchase.

Your last tenant was in the property for several years.

The property has been rented at commercial rates through a real estate agent.

Major works were required to the property.

After examining cost effective ways to do the works, you decided to rebuild.

The proposed rebuilt property should rent for over three times its previous rental amount.

In July 2010 you started demolition and due to delays with the builder's licence you were not able to start construction until early 2011. The house is due to be completed in early 2012.

The property will be tenanted on its completion. You intend to continue long term rental.

The tenant moved out in July 2010 and the last rent for the house was received in July 2010. The rental income should commence again in early 2012.

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.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

o it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478, 

o there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47, and

o it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Generally, 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.

Expenses you incur on a rental property while it is rented or is available for rent are generally allowable deductions. However there are circumstances when a property is not rented and a deduction may still be allowable.

Taxation Ruling TR 2004/4 considers deductions for interest expenses incurred prior to the commencement of income earning activities 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) as well as the decisions in the Full Federal Court. In Steeles case, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. Although the ruling discusses interest expenses, the principles apply equally to holding costs such as land tax and rates. Taxation Ruling 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:

o the interest is not incurred too soon, is not preliminary to the income earning activities, and is not a prelude to those activities,

o the interest is not private or domestic,

o 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,

o the interest is incurred with one end in view, the gaining or producing of assessable income, and

o continuing efforts are undertaken in pursuit of that end.

In your case you have incurred costs for land tax, land rates and water rates for your rental property while it is being rebuilt. The property has been and will be solely used as an income producing rental property. There is no intended private or domestic purpose for holding the property. The length of time between deriving assessable rental income from the property is not considered to be so long that the necessary connection between the holding costs and the assessable income is lost. In these circumstances the land tax, land rates and water rates expenses are not considered to have been preliminary or incurred at a point 'too soon' before the continuation of your income producing activity. Therefore, you are entitled to a deduction for these costs under section 8-1 of the ITAA 1997.