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Ruling

Subject: Rental deductions

Question 1

Are the expenses paid from the settlement date (interest, strata fees, rates, land tax, decline in value and borrowing costs) fully tax deductible?

Answer

No

Question 2

Are deductions allowed for the interest, strata fees, land tax, decline in value and borrowing costs for the period up until the date you decided to put the property up for sale?

Answer

Yes

Question 3

Is any deduction allowed for decline in value?

Answer

Yes

Question 4

If the costs cannot be claimed as a deduction, can they be included in the cost base of the asset for capital gains tax (CGT) purposes?

Answer

Yes

This ruling applies for the following period

Year ending 30 June 2012

The scheme commenced on

22 March 2011

Relevant facts

You and your spouse purchased a property in 2011.

At the time of the purchase you were advised that the large balcony area and the roof were to be resealed and the balcony area retiled in the immediate future. The water ingress in one of the bedrooms was to be corrected also.

You were advised by the body corporate that funds had been allocated to pay for this work and that the work would start very soon after settlement.

You accepted this as you purchasing the property solely for investment purposes and intended to rent the property immediately after settlement.

Due to the slow processes of the body corporate committee, renovations to the building were delayed, with the work commencing belatedly in 2011.

The property has been available to rent since settlement and was listed with an agent.

You have provided copies of letters from your real estate agent.

There was a potential tenant prepared to rent, however due to delays in the renovations to the building the tenant lost interest.

You have found it difficult to find a tenant who is prepared to live in a property with construction in progress.

The estimated completion of the renovations is the end of 2013.

Due to the frustration of dealing with delays and lack of tenant interest you have subsequently sold the property in 2012.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 40-30(1).

Income Tax Assessment Act 1997 subsection 110-25(3).

Income Tax Assessment Act 1997 section 110-35.

Income Tax Assessment Act 1997 subsection 110-35(2).

Reasons for decision

Summary

You are entitled to a full deduction for interest, strata fees, rates, land tax, and borrowing costs from your settlement date up until you put the property up for sale.

When you decided to put the property up for sale your intentions changed from earning assessable income to that of holding the property. You are therefore not allowed a deduction from this time.

A decline in value) deduction is allowed for assets that were installed and ready for use during the period the property was available for rent.

You can include expenses incurred for interest, strata fees, land tax, after the property ceased being income producing in the properties cost base.

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.

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, insurance and interest.

· 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.

Taxation Ruling TR 2004/4 discusses at paragraph 36, the concept of 'continuing efforts' and states that the concept of continuing efforts should not be taken to require constant on-site development activity. It adds further:

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.

You purchased the property in March 2011 with the intention of renting it out. However at that the time of purchase, you were advised that the large balcony area and roof was to be resealed and the balcony area retiled, also that the water ingress in a bedroom was to be corrected.

The property was available for rent and was listed with an agent and you had been actively looking for a tenant. However due to delays in renovations you have been unable to attract any tenants willing to live in property while this work was being carried out.

Due to the frustration of dealing with the delay in renovations and lack of tenant interest you decided to sell the property. The property was subsequently sold in February 2012.

You are therefore entitled to a full deduction for interest, strata fees, rates, land tax, and borrowing costs from your settlement date up until you put the property up for sale.

After this time your intention changed from earning assessable income to that of passively holding the property. It is considered that the necessary connection to deriving rental income was lost at this time.

Therefore the interest expense, strata fees, rates, land tax and borrowing costs incurred from this time are not deductible.

Decline in Value

Division 40 of the ITAA 1997 deals with deductions for the decline in value of depreciating assets.  Division 40 allows you to deduct an amount equal to the decline in value of a depreciating asset (an asset that has a limited effective life and that is reasonably expected to decline in value over the time it is used) that you hold. 

Section 40-25 of the ITAA 1997 states that you can deduct an amount for the decline in value of a depreciating asset you hold to the extent that you use it for a taxable purpose. The effective life starts when you begin to use the asset or have it installed ready for use.

In your case a decline in value deduction is allowed for assets that were installed and ready for use during the period the property was available for rent.

CGT

Section 110-25 of the ITAA 1997 provides that the cost base of a CGT asset consists of five elements.

Where relevant the third element is the non-capital costs of ownership of an asset. A non-capital cost of ownership of an asset is any expenditure in connection with the continuing ownership of the asset. These costs include interest on money borrowed to acquire an asset, costs of maintaining, repairing and insuring an asset, rates and land tax.

Accordingly you can include expenses incurred for Interest, strata fees, land tax, after the property ceased being income producing in the properties cost base.