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Ruling

Subject: Rental property - interest deductions

Question 1

Are you entitled to a deduction for interest in relation to vacant land where you commence construction of a rental property within 12 months?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

You signed a contract and paid a deposit to purchase a block of land during the 2012-13 income year.

The title on the land is not expected to register for some time.

You intend to build a rental property on the land.

You will begin obtaining quotes from builders; however you do not expect to be able to obtain finance to commence construction immediately.

You anticipate that you will have engaged a builder and commenced construction within 12 months of signing the contract.

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) 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.

In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. In considering the above decision Taxation Ruling 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:

· 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.

In your situation, you will incur interest charges on borrowed funds used to acquire vacant land upon which you intend to construct a house that will be solely used to produce income. You expect there may be a delay in you being able to obtain finance to commence the construction of the rental property.

Your efforts to pursue your goal of constructing the rental property will include obtaining quotes from potential builders. You will commence building within 12 months of signing the contract. The house will be available for rent on completion.

In your circumstances the interest expense will not be considered to have been preliminary or incurred at a point too soon before the commencement of the income producing activity and the length of time between the purchase of the land and the commencement of construction will not be so long that the necessary connection between the interest outgoings and the assessable income is lost.

Accordingly, you are entitled to a deduction for the interest expenses for the vacant land under section 8-1 of the ITAA 1997.

Note

It is important to note however, the interest will only be deductible as long as your intention to hold the property for income producing purposes remains the same. If your intention changes and you no longer hold the property for rental income purposes, you cannot claim a deduction for the interest after your intention changes.