Edited version of private advice

Authorisation Number: 1051749474378

Date of advice: 3 September 2020

Ruling

Subject: Interest expense and vacant land

Question 1

Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for interest paid during the time of construction for the income year ending 30 June 20XX for the property that was originally a rental property?

Answer

Yes, under section 8-1 of the ITAA 1997 you are entitled to a deduction during the time of construction for interest incurred up until 30 June 20XX on funds borrowed to finance the purchase of a rental property which you demolished to build three townhouses.

Question 2

Are you entitled to a deduction under section 8-1 of the ITAA 1997 for interest paid during the time of construction after 1 July 20XX for the property that was originally a rental property?

Answer

No

Please refer to Reasons for decision.

This ruling applies for the following period

Year ended 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

You purchased a residential property (the property).

The property was immediately available for rent after purchase and started earning rental income.

The purchase of the property was funded by an investment loan.

Various amounts were spent towards drawings and approvals for construction of several new dwellings on the property.

A few years after purchase the original dwelling was demolished.

Approximately six months after the original dwelling was demolished a building contract was entered with a local builder for the construction of several new dwellings on the property.

The construction was to take approximately 12 months.

The construction was funded with a loan.

Approximately two years after the original dwelling was demolished the certificate of completion was issued.

The new dwellings remain on a single title.

Soon after the certificate of completion was issued the new dwellings were available for rent.

You are receiving rental income from all new dwellings.

You have not participated in the development of any other properties and do not intend to develop any other properties in the future.

You are not carrying on a business of property development.

You live in another state and have never lived in or have any intention to live where the property is located.

You do not intend to sell any of the new dwelling.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 26-102

Reasons for decision

Detailed reasoning

Question 2

Division 26 was amended, such that as from 1 July 2019, income tax deductions of expenses associated with holding vacant land will be limited to the extent the land is in use in carrying on a business at a particular time.

Section 26-102 seeks to limit the situations in which tax deductions can be claimed for holding vacant land.

The provision does not apply to:

(a)          land which is not considered to be vacant (i.e. contains a substantial or permanent structure in use or available for use)

(b)          corporate tax entities, superannuation plans (other than self-managed superannuation funds), managed investments trusts, public unit trusts (covered entities) or unit trusts or partnerships where all the members are covered entities.

Therefore, from the introduction of the legislation on 1 July 2019 income tax deductions to taxpayers will be denied for losses and outgoings incurred in holding vacant land, regardless of when acquired, to the extent the land is not at the time of incurring the expense or outgoing

·         used or held available for use by the entity in the course of carrying on a business in order to earn assessable income; or

·         used or held available for use in carrying on a business by:

-        an affiliate, spouse or child of the taxpayer; or

-        an entity that is connected with the taxpayer or of which the taxpayer is an affiliate

Section 26-102(4) states that for the purposes of paragraph (1)(b), treat a building as not being a substantial and permanent structure if it is *residential premises constructed, or *substantially renovated, while you hold the land unless:

(a) the residential premises are lawfully able to be occupied; and

(b) the residential premises are:

(i) leased, hired or licensed; or

(ii) available for lease, hire or licence.

Therefore, land is vacant until the structure is lawfully able to be occupied and used or available for use (e.g. no deduction during construction).

Expenses for which deductions will be denied that would ordinarily be a cost base element (such as borrowing expenses and council rates) may be included in the cost base of the asset for capital gains tax (CGT) purposes when sold.

In your circumstance you decided to build several new dwellings on the property which you purchased and rented out for a number of years.

Once you demolished the existing dwelling, the property is considered vacant land until the new residential premises (substantial and permanent structure) are lawfully able to be occupied and are leased or available for lease.

Conclusion

As there is no substantial and permanent structure in use or available for use on the block of land, deductions will be denied for interest payments incurred in holding the vacant block of land until the new dwellings were available for rent.