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Ruling

Subject: Interest deductions

Question

Are you entitled to a deduction for interest incurred before construction of the rental property is completed?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts

You own a residential rental property which has been rented out since you acquired it.

Approximately two years ago you began the process of building a dwelling on the back of this property with the intention to keep and rent out on completion.

The development was approved by council approximately one year ago and since this time you have incurred expenses on items directly related to the creation of the second dwelling, including council, water, sewer and town planning costs.

You used borrowed funds to pay for these expenses.

Construction of the new dwelling is to start soon.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

You are entitled to a deduction for the interest expenses incurred as they are not considered to have been incurred at a point 'too soon' before the earning of assessable income from the rental property.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature. 

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. 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

§ continuing efforts are undertaken in pursuit of that end.

In your situation, the interest was incurred on borrowed funds used to subdivide your land and to construct a house that is to be solely used to produce income. Your efforts to pursue your goal of constructing the rental property included gaining council approval for the development and town planning costs.

The interest expense is not considered to have been preliminary or incurred at a point too soon before the commencement of the income producing activity. Therefore you are entitled to a deduction for the interest.