Edited version of your written advice

Authorisation Number: 7920125835754

Date of advice: 1 June 2018

Ruling

Subject: Rental property interest expenses

Question

Can you claim all of the interest on a loan used to purchase a vacant block of land, part of which will be used for a carpark?

Answer

No, the total amount of deductions will be limited to the amount of income received.

This ruling applies for the following periods

Year ended 30 June 20xx

Year ended 30 June 20xx

Year ended 30 June 20xx

The scheme commenced on

1 July 20xx

Relevant facts

You are considering buying a vacant block of land.

You consider that you may have potential tenants for up to 3 carpark spaces on the block of land.

You expect to incur more than $XX p.a. interest on a loan to purchase the land.

You expect to generate less than $X p.a. income from leasing the carparks.

You intend to sell the property to realise a capital gain within 5 years.

You don’t intend to build on the land, as there are factors which make it difficult to build on. You may build a house on it when you come to sell it, in order to increase the value of the land.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Rental income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes all ordinary income derived directly or indirectly from all sources.

Rental income is considered ordinary income for the purposes of section 6-5 of the ITAA 1997 and is therefore assessable.

Expenses

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, or relate to the earning of exempt income.

Generally, rental property expenses incurred for income producing purposes are deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature.

If the money is borrowed for the purpose of, or applied in, producing both assessable and non-assessable income, rather than producing only assessable income, the interest expense may need to be apportioned (see Ronpibon Tin NL v. FC of T (1949) 78 CLR 47 at 59; 8 ATD 431 at 437 (Ronpibon Tin); Kidston Goldmines Ltd v. FC of T 91 ATC 4538 at 4544-46; (1991) 22 ATR 168 at 175-177). This is a question of fact.

Regarding apportionment it has been stated (Brennan J in Ure v. FC of T 81 ATC 4100; 11 ATR 484)

If the borrowed moneys had been laid out solely for the purpose of gaining assessable income, the interest would be wholly deductible; but as they were laid out in part for that purpose, and in part for other purposes, the interest charges must be apportioned.

While the cases above discuss interest, the principle can be applied equally to other expenses.

Taxation Ruling TR 95/33 considers the deductibility and apportionment of losses and outgoings where expenses are incurred for dual purposes. TR 95/33 states that if an outgoing produces an amount of assessable income greater than the amount of the outgoing, there would normally be no need to examine the taxpayer's motives and intentions when determining the deductibility of the expenditure.

However, if the outgoing produces no assessable income, or the amount of assessable income is less than the amount of the outgoing, it may be necessary to examine all the circumstances surrounding the expenditure to determine whether the outgoing is wholly deductible. This may, depending on the circumstances of the particular case, include an examination of the taxpayer's subjective purpose, motive or intention in making the outgoing.

If it is concluded that the disproportion between the outgoing and the relevant assessable income is essentially to be explained by reference to the independent pursuit of some other objective, then the outgoing must be apportioned between the pursuit of assessable income and the other objective: see Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613 (Fletcher’s Case)

As explained in Ure's case and Fletcher's case, in determining the deductibility of expenses it is necessary to consider the motive/purpose in incurring the loss/outgoing.

You have indicated that you wish to purchase the land, rent out as a car park and then sell it for a capital gain in a few years.

Consequently, if the immediate or direct object intended to be achieved from the outgoings is not the production of assessable income which is commensurate with the outgoing, it will be necessary to determine if the expenses associated with the rental property can genuinely be characterised as outgoings incurred in gaining or producing assessable rental income

It is clear from your statements that the ultimate motive for purchasing the property is not to produce assessable income from the rental of the car parking spaces. The disparity between what would normally be expected for a property purchased at the price you estimate and the amount you will receive as rental for the car parking spaces is far too great to indicate that your purpose was for gaining or producing assessable rental income.

Therefore, any deduction for the expenses you will incur will need to be apportioned to reflect your ultimate purpose.

When it is necessary to apportion a loss or outgoing, the appropriate method of apportionment will depend on the facts of each case. However, the method adopted in any particular case must be both 'fair and reasonable' in all the circumstances (Ronpibon Tin). In Fletchers Case, it was 'fair and reasonable' to limit the amount of the deduction to the amount of the assessable income actually received in that year.

Taxation Ruling IT 2684 considers the circumstances in which interest on money borrowed to acquire units in a property unit trust is an allowable deduction. In that Ruling, the Commissioner considers that, in general, interest expenses incurred on borrowed funds used to purchase income units, capital growth units or combined units (units offering returns of both income and capital growth) are an allowable deduction. However, the Commissioner considers that there are exceptions to the general rule.

Your case is somewhat analogous with a capital growth split property unit trust, in which the investor is entitled primarily to capital growth, but which may also produce some assessable income.

The Commissioner’s view with respect to capital growth split property units is that where such units are expected to produce only negligible income, interest expenses incurred in borrowing money to purchase the units are deductible only up to the extent of the assessable income actually received.

Having regard to all the circumstances, it is considered fair and reasonable to adopt the same approach in your case. Therefore, a deduction for all expenses relating to the property will only be allowed up to the amount of the rent received.