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Ruling

Subject: Rental property expenses - property not tenanted

Question

Are you able to claim a deduction for rental property expenses such as interest, rates and land tax in respect of a property which has not been tenanted for more than two years, and is not expected to be in an income producing condition for at least another eighteen months?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You purchased a property several years ago which was rented to tenants until approximately two and a half years ago.

At this time you ceased advertising for tenants as there was structural damage to the property.

Your original intention was to rectify this damage, undertake some renovation and re-let the property.

The damage was more extensive then initially believed and the decision was made to demolish the property.

The house was demolished almost a year ago.

You have since been incurring expenses for interest, land tax, council rates and maintenance.

You intend to construct income producing properties on the property. However you wish to defer construction of these properties until the release of a revitalisation strategy being developed by the local council.

This strategy is not expected to be completed for another 18 months, during which time your property will remain vacant and not be income producing.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

Rental property expenses are not deductible due to the link between the expenditure and the income being lost, and there is no active pursuit of the goal of producing assessable income

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 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 in relation to the deductibility of expenses incurred in gaining or producing assessable income have been established through the views taken by the Courts, Boards of Review and Administrative Appeals Tribunals.

It is not necessary that the expenditure in question should produce assessable income in the same year in which the expenditure is incurred. In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (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.

While Steele's Case deals with the issue of interest, the principles can be applied to other types of expenditure including rates and insurance.

Taxation Ruling TR 2004/4, in considering the above decision, 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. While this does not require constant on-site development activity, the requirement is not satisfied if the venture becomes truly dormant and the holding of the asset is passive, even if there is an intention to revive the venture at some time in the future.

In your case, you have held the rental property for a number of years. However it has not been income producing for two and a half years and will not be income producing for at least another eighteen months.

The rental property expenses are not private or domestic. However the period which has elapsed and will continue to elapse before the property is again income producing is considered to be too long.

Although the property initially was not let to tenants due to rectification of structural damage, a conscious decision has been made to delay construction for a further eighteen months. As such the necessary connection between outgoings and assessable income is lost.

Furthermore, you do not intend to make any continuing efforts in pursuit of the end of making the property income producing. Continuing efforts would include engaging architects, obtaining planning permits and the like; however your intention is for the property to remain dormant until such time as the new planning scheme is in place. This would not be considered to be making a continuing effort even if there is an intention to construct income producing properties in the future.

You are therefore not entitled to claim ongoing expenses such as interest, rates and land tax in respect of your rental property.