Edited version of private advice

Authorisation Number: 1051606195854

Date of advice: 11 November 2019

Ruling

Subject: Rental property holding expenses

Question

Are you entitled to a deduction for property holding costs such as interest, council rates and taxes, depreciation for the period the property was not rented?

Answer

No.

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

You purchased a property off the plan and took possession.

You had intended to move into the property for some months and then rent it out.

Water leaks were found, making it dangerous and uninhabitable.

You ceased to move into the property and provided access to the builder to remedy the issue.

Over several years engineers and specialists were brought in to determine the problem.

The builder made a number of repairs and you sought legal advice.

You were advised by the builder that they were confident they had fixed the water leak issue. You moved into the property with the intention of living in it for at least a few months and then renting the property out.

The leaks returned, and you had to move out after less than X months.

You had planned to have the property rented, but this was not possible due to the ongoing water leak issue.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

You are not entitled to a deduction for interest and holding costs from the time that the property became vacant as it is considered that the connection to the income earning aspect of the property has been broken, as before it could be rented, the property would be your private residence.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 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.

In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139 (Steeles Case), the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. It follows from Steeles 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 Steele's Case deals with the issue of interest, the principles can also be applied to other types of expenditure including local council, water and sewage, rates, land taxes and emergency services levies.

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 sometime in the future.

In your case, you had a property constructed with the intent to move into it for a short period of time before renting it out.

However, at that time construction was completed, the property was not in a habitable condition. It is considered that continuing efforts to derive assessable income are not being undertaken. You have not been in a position to rent the property since it was built.

It is acknowledged that you have undertaken continuing efforts to make it habitable, however this was to make is possible for you to move in to make it your private residence, albeit for a short period of time.

The connection between your expenses and any rental income was never established because of the uninhabitable condition of the property from when it was built, and the fact that it was to be your principal place of residence once it was habitable. It is considered that the necessary connection to deriving rental income has not been created.

Therefore the interest expense and holding costs such as council rates, water rates, and insurance incurred are not deductible under section 8-1 of the ITAA 1997.