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Ruling

Subject: Expenses incurred prior to completion of construction

Question 1

Are you entitled to a deduction for your share of the interest, rates and other holding costs with respect to the vacant land which you purchased with the intent to construct a residential rental property from the time you purchased the land?

Answer: No.

Question 2

Are you entitled to a deduction for your share of the interest, rates and other holding costs with respect to the vacant land which you purchased with the intent to construct a residential rental property from the time you signed a pre-construction contract with the builder?

Answer: Yes.

This ruling applies for the following periods

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 2007

Relevant facts and circumstances

Approximately four years ago, you and other parties purchased a block of land on which it was intended to build a rental property.

A few weeks after signing the contract, the project had to be put on hold due to an expanding family which meant less income.

Various other personal circumstances of the co-owners meant that a pre-construction contract was not signed with the builder until approximately 18 months ago.

Due to scheduling conflicts between the co-owners and the builder, the commencement of construction was delayed for a time.

Practical construction was completed recently with final finishing, including fencing, flooring, painting, paving and landscaping to be completed shortly.

The property will be available for rent and an agent will be found to manage the property once the final details are completed which is anticipated to be in approximately a month.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

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.

Interest on funds used to purchase a property on which the taxpayer intends to build an income producing asset may be deductible, from the time of the acquisition of the property (Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139) (Steele's Case). It follows from Steele's 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. While this does not require constant activity, the requirement is not satisfied if for a period of time the venture becomes 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.

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

In your case, you incurred interest and other holding costs in relation to the land purchase from the time of purchase approximately four years ago.

Your intention has always been to build a rental property on the land once your financial position was secure.

From the land purchase until the pre-construction contract was signed, it is considered that your plans to build a rental property on the land were essentially dormant and your holding of the asset during this time was passive, even though your intention was to continue the venture at some time in the future. The reason for the delay was your financial position and not any factors intrinsic to the property development itself.

Therefore, the interest expenses and other holding costs you incurred during this period are not deductible as the necessary connection between the outgoings and assessable income is too remote.

However, it is accepted that from the time you signed the pre-construction contract with the builder that you were making continuing efforts in pursuit of the construction to be used solely for income producing purposes. Also, the period of time between the signing of the pre-construction contract and the proposed completion date is not considered to be so long that the necessary connection between the holding costs and the derivation of income is lost.

Accordingly you are entitled to a deduction for your share of interest, rates and other holding costs relating to this property from the time the pre-construction contract was signed.