Edited version of private advice

Authorisation Number: 1052218614752

Date of advice: 8 February 2024

Ruling

Subject: Capital gains tax

Question 1

Will there be a Capital Loss when the property is transferred to Company Z at the market value?

Answer

Yes.

Question 2

Are you able to claim a deduction for all the interest on the bank loan taken out to purchase the land and construct the dwelling?

Answer

No.

Question 3

Can you claim a pro-rata deduction for the interest received from Company Z for the vendor finance loan?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You purchased a vacant block of land.

Land deposit was paid.

Building contract was signed shortly after the deposit was paid.

Land settlement occurred in the following month.

You borrowed through a split facility secured against your main residence.

You have paid a number of expenses to date.

You have engaged Company Y to construct the dwelling on the land.

Company Y are an unrelated entity.

Currently the dwelling is under Construction.

The property is currently at lockup stage and tiling and floors nearly finished.

You realised a couple of months ago that you made a mistake purchasing the vacant land in your name and constructing a dwelling on the land in your name.

You intend on transferring the property to Company Z.

A Trust owns Company Z.

The trustee is Company X.

You are a Director and Shareholder of the trustee company.

You are an eligible beneficiary under the trust deed.

You intend on transferring the property to Company Z in a number of weeks.

It is intended that the property will be completed, inspected and post-handover at the time it is transferred to Company Z.

Tenants may or may not be in place depending on timing of the transfer to Company Z.

The sale price is to be set at market value when transferred to Company Z.

The loan you make to Company Z will be in writing.

The interest rate on this loan will be the same as the loan you took out and calculated in the same way.

The loan will be secured by mortgage.

The property will not produce any assessable income prior to it being transferred to Company Z.

You intend that the property will commence producing assessable income a few months after the construction on the property is completed.

You are not in the business of property development.

This is the first property construction project you have undertaken.

You do not intend on constructing any more properties in the future.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Reasons for decision

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a capital gain or capital loss is made only if a capital gains tax (CGT) event happens to a CGT asset. The Property is a CGT asset.

CGT event A1 happens under section 104-10 of the ITAA 1997 if a change in ownership of a CGT asset occurs.

Therefore, CGT event A1 will happen when you transfer the property to Company Z.

You make a capital gain if your capital proceeds from the sale of a CGT asset are greater than the cost base for the purchase of that asset, for example, if you receive more for an asset than you paid for it.

You make a capital loss if your reduced cost base for the purchase of that asset is greater than the capital proceeds resulting from the sale of that asset, for example, if you receive less for an asset than you paid for it.

You intend on transferring the property to Company Z once the construction has been completed.

You anticipate that the transfer will take place early this year.

Company Z will pay a sum which you believe is the market value of the property.

You will make a loss on the transaction when you transfer the property to Company Z.

Section 8-1 of the 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.

TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities considers the decision in Steele v Deputy Commissioner of Taxation [1999] HCA 7; 197 CLR459 (Steele's case) and 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, considering 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.

Subsection 26-102(1) of the ITAA 1997 limits the deduction on the amounts relating to holding land if at that time of incurring the loss or outgoing there is no substantial and permanent structure in use or available for use on the land.

This means that 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 while carrying on a business for the purposes of gaining or producing 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 relates to the taxpayer or of which the taxpayer is an affiliate

Subsection 26-102(4) of the ITAA 1997 states that residential premises that you construct or substantially renovate will be treated as not being a substantial and permanent structure until they can lawfully be occupied and are leased, hired or licensed (or available for lease, hire or licence).

In your case, it is considered that there was not a permanent and substantial structure on the land as the premises was not lawfully occupied prior to the time the property was transferred to Company Z.

Therefore, you are not entitled to claim holding costs in relation to the land.

The costs involved in holding vacant land include:

•                     ongoing borrowing costs, including interest payments on money borrowed for the acquisition of land

•                     land taxes

•                     council rates

•                     maintenance costs

They do not include interest payments on money borrowed for the construction of the permanent and substantial structure. You will be entitled to the portion of interest expenses associated with the construction costs. Where the loan is singular and the interest payments covers both the land and the construction of the permanent and substantial structure, you must carefully apportion the interest with reference to the cost of the land and building.

You can claim the construction costs up until the purpose of the loan changed.

At that time, you realised that you had made a mistake in taking out a loan to purchase land and constructing the dwelling.

You realised that Company Z should have taken out the loan.

The purpose of the loan changed at this time from one of investment to one of selling a property.

You will transfer the property to Company Z for its market value.

The purpose of the loan has now changed.

You can claim the interest expense on the portion of the loan that relates to the expenses associated with the construction of the dwelling you incurred up until the intention changed from being an investment property to it being sold to Company Z.

You intend on lending money to Company Z for the purchase of the property.

The interest you receive from Company Z will be declared by you as income.

The loan will be at commercial rates and an agreement will be in writing.

You can claim a deduction for the interest on the loan you make to Company Z because the amount will be equal to the interest income you receive from Company Z.