Edited version of private advice

Authorisation Number: 1052189247745

Date of advice: 9 January 2024

Ruling

Subject: Am I in business - holding costs for vacant land

Question 1

Can you claim expenses associated with holding the vacant land in the relevant financial year on which you intend to carry on a rental letting activity?

Answer

No.

Question 2

Can you claim expenses associated with renting your proposed properties in the relevant financial year under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

Can you claim a deduction for decline in value or capital works prior to letting your proposed rental properties?

Answer

No.

This ruling applies for the following period:

Financial year ending 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You purchased land with the intention to build a dwelling and offer a relocatable dwelling for short term rentals. The dwelling is also to serve as caretaker's quarters.

The type of business you are proposing is permitted within the zone your land falls in under the local council. The land has always been a vacant lot and still is. You have no outstanding financial commitment on this purchase.

You have commenced initial site preparations that do not require development approval, are in the process of gathering necessary reports to submit plans for the dwelling for development approval, and are investigating the sites suitability for eco-tourism accommodation. Once you get development approval you intend to install relocatable dwellings for glamping and you hope to have these ready to rent out in the following financial year.

You also will need to arrange connection to services, access to the sites and construction of utilities. Your current plan is to have one relocatable dwelling that you can advertise as available to rent by spring the following year, and you are hoping to be able to expand to your operation to include other relocatable dwellings. You are also hoping to landscape the gardens so that you can regenerate the endemic forest environment.

You expect to be living in the caretaker's cottage during the first year of operation while the grounds are landscaped and the relocatable dwelling is fitted out. You intend to rent the caretaker's cottage out in the longer term.

You intend to advertise this accommodation online and through a dedicated web page. Any commission due through these bodies will be paid as per their terms and conditions. You will be listing your accommodation on the mandatory state short-term rental accommodation premises register and complying with the associated code of conduct. You also intend to take out a general insurance package that will be suitable for this activity and cover buildings, contents, and public liability.

You have estimated the projected income from the relocatable dwelling in the first year it is operating based on your research into booking rates, average listing prices, and availability dates for accommodation of a similar nature in the local area. In the following year you believe the caretakers cottage will generate twice that amount.

Your estimated expenses in the relevant financial year include the purchase price of relocatable dwellings, the construction cost of the caretakers cottage, the cost of the landscaping, and the cost of council rates, utilities, and insurance.

Records will be kept using a suitable web-based package that will allow you meet your tax obligations, and you intend managing your activity from a dedicated office located within the caretaker's cottage.

You are currently employed full-time on a shift roster allowing you time to work on this activity, and intend to continue working full time for the next 5 years while establishing the business. Your spouse has no other employment and will be working on the activity through these 5 years. You hope that this activity will then provide an income for you and your spouse through your transition to retirement. Eventually you hope this venture will be successful enough to allow you to employ a full-time caretaker.

You have previously owned other rental properties and run your own small business. Your spouse has worked in catering, and also has experience as a residential cleaner. You have conducted online research of similar businesses and activities, their reservations, and the local council and other tourism websites in the area, and believe there is a market for this style of serviced accommodation.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 26-102

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Reasons for decision

The circumstances under which costs associated with holding vacant land can be claimed as deductions are described in Taxation Ruling TR 2023/3 Income tax: expenses associated with holding vacant land. This ruling describes the operation of section 26-102 of the ITAA 1997 in limiting the costs associated with holding vacant land that can be claimed as deductions. Vacant land is land on which there is no substantial and permanent structure in use or available for use. Residential premises that you install or build will be considered substantial and permanent structures when they are legally certified as fit for occupation and are available for lease, hire, or licensing.

Holding costs for vacant land include expenses such as interest or ongoing borrowing costs, council rates, land tax, or maintenance costs. These costs must be apportioned to account for any private use of the land if they are claimed as deductions. Where these costs cannot be claimed because of the limits applied by section 26-102 of the ITAA 1997 they can be considered part of the cost base of the land for capital gains purposes under Division 110 of the ITAA 1997.

Costs associated with holding vacant land can be claimed as deductions when the land is being used to carry on a business. The factors taken into consideration in determining if a taxpayer is carrying on a business are discussed in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production. While written for primary producers, these indicators are the consolidation of many years of case law and have broad application over many industries. TR 97/11 identifies the following indicators for consideration in determining whether a taxpayer is carrying on a business for taxation purposes:

•         whether the activity has a significant commercial purpose or character

•         whether there is more than just an intention to engage in business

•         whether there is a purpose of profit as well as a prospect of profit from the activity

•         whether there is repetition and regularity of the activity

•         whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

•         whether the activity is planned, organised, and carried on in a businesslike manner such that it is directed at making a profit

•         the size, scale, and permanency of the activity, and

•         whether the activity is better described as a hobby, a form of recreation, or a sporting activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour.

You can claim holding costs for your vacant land if you are carrying on a business of letting rental properties with your proposed relocatable dwelling and possible caretaker's cottage. Your holding of vacant land on which you propose to erect the relocatable dwelling and cottage are assessed against the indicators for being in business as follows:

Whether the activity has a significant commercial purpose or character

An activity can be considered to have significant commercial purpose or character if it has a business plan, a profit-making purpose, and can be shown to be carried on in a commercially viable manner. The business planning process itself includes knowledge of or research into marketing the product or service provided, capital requirements and how these might be met, costs, legal requirements, and the size and scale needed for commercial viability.

You purchased land with the intention to build a caretaker's cottage and offer up to 2 relocatable dwellings for short term glamping rentals. You are planning on having one relocatable dwelling ready to advertise as available to rent with services in the year following the relevant financial year. Depending on the uptake of rental activity for this relocatable dwelling and its financial performance as a rental unit you may go on to install a second relocatable dwelling for the rental market on this basis, and also offer the caretaker's cottage for this purpose in the following financial year. You have paid for the land and estimated the cost of establishing your facility. You have also investigated the legal requirements for short term serviced accommodation in your locality. The initial scale of your proposed activity, one relocatable dwelling with additional services, is small. As at the time of the relevant financial year there will be no dwellings on the property used for income producing purposes.

Whether there is more than an intention to engage in business

For a business to be carried on there must be activity that has a direct connection with the generation of income. Activity that is preparatory in nature or experimental will not be considered a business. Your income generating activity will commence when you are able to advertise your relocatable dwelling as genuinely available for rent in the year following the relevant financial year. There will be no income generated from the property in the relevant financial year.

Whether there is a purpose of profit as well as a prospect of profit from the activity

A business must have a purpose as well as a prospect of profit. This includes planning and activity that is directed towards making a profit and being able to demonstrate how that profit is to be made. You have researched the market for this type of rental accommodation in your area and estimated your start-up costs and income from this activity once established. You are hoping that income from this activity will support you and your spouse as you transition into retirement, and that you can eventually employ someone else to undertake the caretaking functions of your planned accommodation. While you have a purpose of profit the prospect will be uncertain until you are undertaking this activity and can make decisions based on its financial performance. During the relevant financial year you will not make a profit from the activity as there will be no dwellings let on the property.

Whether there is repetition and regularity of the activity

Activity must be undertaken on a continuous and repetitive basis, as appropriate to the industry, for it to be considered a business. You and your spouse anticipate spending 20 hours a week each through the initial preparatory stage of your activity up to and including the time you can begin taking paying guests. Prior to that time you are planning to live in the cottage as caretakers of the property, and to write policies and procedures in the hope that you will be able to employ others as caretakers of your rental property at this location. You have other full-time work that provides you with an income. There will not be repetition and regularity of renting out dwellings on the property in the relevant financial year.

Whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business

An activity can more readily be recognised as commercial if it is of same kind and carried on in a similar manner to other businesses in the same industry. Your anticipated costs for the relevant year include council rates, water, electricity, and insurance. You will not be letting out any dwellings and earning income in the relevant financial year.

Whether the activity is planned, organised, and carried on in a businesslike manner such that it is directed at making a profit

An activity can more readily be characterised as a business when it is carried on in a planned, organised, and businesslike manner such that it is directed at making a profit. You intend to keep your business records on a web-based application that will allow you to meet your taxation obligations. You intend to make space available in the caretaker's cottage to keep and maintain your records. During the relevant financial year you will not be carrying out an activity of letting any dwellings on the property to make a profit.

The size, scale, and permanency of the activity

An activity would be expected to be of a size, scale, and permanency suitable to the industry it is operating in to be recognised as a business. Your short-term rental activity is still in the planning stages and is yet to be brought to the point that it is capable of producing income. You anticipate you will be able to take bookings for one relocatable dwelling in the year following the relevant financial year, and possibly more in following years. This is on a small scale and further expansion of your activity will depend on your initial installation of that one relocatable dwelling achieving your anticipated bookings target. Letting out one relocatable dwelling on a property would not be regarded as carrying on a business. It would be viewed as an investment activity.

During the relevant financial year there will be no dwellings on the property being let.

Summary of these indicators

Your activity in the relevant financial year can be characterised as preparatory to being in business, and your proposed letting of one relocatable dwelling in the year following the relevant financial year a pilot project exploring the longer-term potential of the activity as a viable business. You have not commenced commercial operations, the proposed initial offering is on small scale, and the prospect of profit uncertain. You are not in business with your rental letting activity in the relevant financial year.

As you are not in business with your rental letting activity you will not be able to claim holding costs for your vacant land in the relevant financial year.

Question 2

Can you claim expenses associated with renting your proposed properties in the relevant financial year under section 8-1 of the ITAA 1997?

Summary

As your proposed relocatable dwelling and caretaker's cottage will not be generating income or genuinely available to rent you cannot claim any deductions for expenses associated with their letting under section 8-1 of the ITAA 1997 in the relevant financial year.

Detailed reasoning

Income from letting rental properties is assessable income under section 6-5 of the ITAA 1997. A wide range of expenses associated with generating income from a rental property can be claimed as deductions under section 8-1 of the ITAA 1997. These expenses can only be claimed for periods in which your property is rented or genuinely available to rent, must be apportioned to the extent the property has been used for private purposes, and do not include capital costs. To be considered genuinely available to rent a property must be advertised as available to rent and tenants reasonably likely to rent it.

The expenses you can claim under section 8-1 of the ITAA 1997 are limited if they are specifically excluded by another section of that Act. Expenses relating to travel to and from rental properties are excluded for property investors under section 26-31 of the ITAA 1997 but can be claimed if you are carrying on a business of rental letting.

In your case you will not be advertising your proposed relocatable dwelling as available to rent until the year following the relevant financial year. As these properties will not be generating income or genuinely available to rent, and you are not carrying on a business, you cannot claim any deductions for expenses associated with their letting under section 8-1 of the ITAA 1997 in the relevant financial year.

Question 3

Can you claim a deduction for decline in value or capital works prior to letting your proposed relocatable dwelling or caretakers cottage?

Summary

You will not be able to claim decline in value or capital works deductions for your proposed rental accommodation until you advertise it as genuinely available to rent.

Detailed reasoning

Costs associated with the establishment of assets used to generate income are deductible over a period of time as the cost of a decline in value of depreciating assets or capital works expenses (Division 40 and Division 43 of the ITAA 1997).

Depreciating assets are freestanding, have their own function, and can be removed without damage to the item or the property. Deductions for the depreciating value of these items must be claimed over a number of years, and the amount that can be claimed each year is based on the effective life of the item. The effective life for most depreciating assets is listed in Taxation Ruling TR 2022/1 Income tax: effective life of depreciating assets (applicable from 1 July 2022), including relocatable and manufactured homes. The effective life for manufactured relocatable homes is 30 years. The methods used to calculate the amount that can be claimed each year are described in the Australian Taxation Office publication Rental Properties 2023 (NAT 1729-06.23).

Expenses for capital works include construction costs for building and structural improvements or features that are integral to the asset and fixed to the property. Deductions for capital works, as discussed in Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements, are based on the amount of expenditure incurred constructing income producing assets. For residential properties used to generate rental income this might include the costs of the construction or installation of the residential buildings as well as associated features such as patios, sealed driveways, carports, retaining walls and fences, but not the costs associated with landscaping. Deductions for these costs can only be claimed from the date construction is complete and, for rental properties, the date the property is rented or available to rent. These deductions must be claimed over 40 years. Costs claimed as capital works deductions cannot be included in the cost base for capital gains, and must also be apportioned for any private use of the asset.

Costs associated with landscaping would form part of the cost base for capital gains purposes when you sell the property.

You will not be able to claim deductions for decline in value or capital works for your proposed relocatable dwelling or caretaker's cottage until installation or construction is complete and they are rented or advertised as genuinely available to rent (held ready for use for a taxable purpose). You will not be able to claim a decline in value or capital works deduction for them in the 2023-24 financial year.