Edited version of private advice

Authorisation Number: 1052296915354

Date of advice: 05 September 2024

Ruling

Subject: Interest deductions/rental properties

Question 1

Are you entitled to a full deduction for the loan interest incurred prior to the dwelling being lawfully available for rent?

Answer 1

No.

Question 2

Are you entitled to an apportioned deduction for the loan interest incurred in relation to the construction of the dwelling prior to the dwelling being lawfully available for rent?

Answer 2

Yes - where the land loan and construction loan are combined, a deduction will only be available for the element of the loan interest and other borrowing costs that relate to the construction of the residence and the interest will need to be apportioned. See paragraph 26 and example 6 in Taxation Ruling 2023/3

This private ruling applies for the following period:

Year ending XX June 20XX.

Year ending XX June 20XX.

Year ending XX June 20XX.

The scheme commenced on:

20 July 20XX

Relevant facts and circumstances

This private ruling is based on the facts and circumstances set out below. If your facts and circumstances are different from those set out below, this private ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an Australian resident for tax purposes.

You and your spouse purchased a house and land package in June 20XX as joint tenants.

It was your intention to build an investment property on the land.

You took out an 'interest only' loan with a bank to finance the purchase of the land, and construction of the dwelling.

You began renting the Property out in July 20XX.

You have been incurring interest on the loan.

Relevant legislative provisions

Income Tax Assessment Act section 8-1

Income Tax Assessment Act section 26-102

Reasons for decision

Summary

You cannot claim a deduction for interest expenses to hold vacant land prior to the Property being available for rent, or actually being rented.

You are entitled to an apportioned deduction for the loan interest incurred in relation to the construction of the dwelling prior to the dwelling being lawfully available for rent. For more information on interest deductions relating to rental properties, search QC 101711 at ato.gov.au.

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.

Expenses incurred relating to a rental property are deductible under section 8-1 of the ITAA 1997 if the property is rented or available for rent in the income year in which you claim the deduction. Interest on loan used to purchase a property which is rented or available for rent is an allowable deduction under section 8-1 of the ITAA 1997.

Taxation Ruling 95/25 ('TR 95/25 ') Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith provides the Commissioner's view on the deductibility of interest expenses following the Full Federal Court decision in FC of T v. Roberts; FC of T v. Smith 92 ATC 4380; (1992) 23 ATR 494 (Roberts and Smith).

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income.

Paragraph 3 of TR 95/25 sets out the general principles relevant to the question of whether interest is deductible under section 8-1 of the ITAA 1997:

•                There must be a sufficient connection between the interest expense and the activities which produce assessable income. The test is one of characterisation, and the essential character of the expenses is a question of fact to be determined by reference to all the circumstances.

•                The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower (the 'use' test).

•                Regard must also be had to all the circumstances, including the objective purpose of the borrowing and the nature of the transaction or series of transactions of which the borrowing of funds is an element. In some cases, your subjective purpose, intention or motive may be relevant (the 'purpose' test).

Interest on vacant land

Subsection 26-102(1) of the ITAA 1997 denies a deduction for losses or outgoings relating to holding land on which there is no substantial and permanent structure in use or available for use. Paragraph 16 of TR 2023/3 states that to be available for use, premises must be capable of being occupied. In the context of residential premises, established residential premises are considered to be available for use unless they have been deemed unsafe to occupy by a council or relevant body.

Expenses related to holding vacant land, including land on which a residential rental property is either under construction or being substantially renovated, or which has a completed residential property that is not available for rent, are not deductible, regardless of when the land was purchased.

Subsection 26-102(4) of the ITAA 1997 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.

This means that land is vacant until the structure is lawfully able to be occupied and used or available for use.

Where the land loan and construction loan are combined, a deduction will only be available for the element of the loan interest and other borrowing costs that relate to the construction of the residence and the interest will need to be apportioned.

Application to your circumstances

At the time the relevant interest expenses were incurred, you were not using the vacant land in carrying on a business, nor were you leasing the land to an entity carrying on a business. You were also not an entity of the type specified in section 26-102 of the ITAA 1997.

Prior to construction of the house, there was no substantial and permanent structure in use or available for use on the land.

Therefore, although you incurred interest expenses relating to your loan, you are denied a deduction for the total amount of interest expenses until such time as the house was lawfully able to be occupied and made available for rent, or actually rented.