Tax Tip 506: Claiming Interest During Construction

It has generally been thought that interest incurred while constructing a residential investment property was no longer deductible since the changes to the law in 2019 (there are some very limited exceptions though). The ATO has now come out saying that interest may be deductible on the construction component.


Paragraphs 26 to 28 of draft tax ruling TD 2021/D5 say

Loss or outgoing relating to holding land

26. Subsection 26-102(1) clarifies that any interest or borrowing costs to acquire land are included as a cost of holding land. Examples of other costs of holding land include council rates, land taxes and maintenance costs.

27. In the context of section 26-102, we do not consider the costs of constructing a substantial and permanent structure on the land, or any interest or borrowing costs (to the extent they are associated with construction), to be a loss or outgoing related to holding land.

Example 6 - interest expense for multiple purposes

28. Giovanna takes out a mortgage to purchase a vacant block of land in September 2019. Giovanna intends to build a house on the land (which she will rent out). Giovanna does not carry on a business. Giovanna takes out a separate loan for the construction of the house. Giovanna will not be able to claim a deduction for her interest expense which relates to acquiring the land until the house is lawfully able to be occupied and leased or available for lease. If a deduction is otherwise available for the construction loan interest expense, Giovanna will not be prevented from deducting the expense by section 26-102.



Draft Taxation Ruling, TR 2021/D5, Income tax: expenses associated with holding vacant land

https://www.ato.gov.au/law/view/document?DocID=DTR/TR2021D5/NAT/ATO/00001&PiT=99991231235958

Note that the ATO conflate the word 'mortgage' with 'loan' - 2 different things. Giovanna could still claim or not be able to claim the interest if it was an unsecured loan with no mortgage.

 

This certainly was good news when released and restored SOME deductions for those who were constructing with intention to later rent. It doesnt help those who seek to sell after completion. The vacant land holding period rules bought a end to steele's type deductions and when it came out in December 2021 it meant the interest on construction could be claimed (D15 deduction !!)

One issue I have found is some people are of the view you can only commence to claim the interest when its completed and available for rent etc. But they seek to backdate it. Ummm no. The interest from vacant land holding period rules adds to the costbase. Had a few argue with me on that.. I explain para 29 of the ruling Terry refers to and they...stop

 

In relation to above - would my thinking that interest on a granny flat construction at the rear of an existing IP (rented out earning income) property would therefore be deductible?

Chees

 

The rules are a bit waffly I believe. The test is that of the land title. s there a permanent structure on it... Seemingly with a house and planned GF there is. Same with a GF. However the ATO then explain some conditions

A substantial and permanent structure is a building or other structure constructed on the land that is:

• significant in size or value
• not incidental to the purpose of another structure or proposed structure on the land
• not related to, reliant on, or exist to support the use or function of another structure
• fixed and enduring (not built for a temporary purpose).

Its possible a GF and a new house to be subdivided aftre completion could fall foul as the new dwellings isnt incidental to the existing structure. What is signiifcant size or value when we refer to a GF ?

There are also catches if the existing dwelling is vacant or renovated during the build. ....

However, if the substantial and permanent structure is residential premises constructed or substantially renovated while you held the land the premises must also be lawfully able to be occupied and either:

• leased, hired or licensed
• available for lease, hire or license or
• where an exceptional circumstances exemption applies

Private rulings may be suggested in some cases if the tax advice is unsure

 

You would need to interpret 26-102

 

In which section would you make this claim in the return? I'm in this situation at the moment with a new build investment property and my accountant has told me that I can't claim any costs until the property has a certificate of occupancy. However, from looking around it appears as though any costs related to land holding are not deductible, but construction costs (i.e. interest on the loan) are in fact deductible as long as they are separated from the land holding.

I spoke to my accountant about it this afternoon who said there isn't even anywhere to claim the interest if it's before the completion date. Would it go into section D15?

 

OMG what a numpty. The ruling is 2 years old and the return preparation basis has been this way for 20 years and they dont know ??

D15 is correct. Under investments. I would enter "Steeles case"" as the granular info goes to ato and it may reduce review issues. Cant believe you are paying them.

 

I don't do tax returns for clients, but it should probably be in the rental property schedule

 

Cant put into a rental schedule. ATO has a check that says - No income so no deduction. So its D15.

In cases where during that year the rent did commence we often split the interest etc so steele's elements are on the rental schedule.

Another common one is interest for divs and ETfs etc. Where do I claim. If you have ETFs claim at 13.. If its shares Deductions for shares expenses D8. If its both just claim at 13 OR D8

 

NTAA had previously suggested it should go in the rental schedule, from memory

 

If rental income has commenced in the year. yes. No need to split it for the part before rent and post rent. If no rental income the validation test fails without income and D15 is correct. This is because its not a rental property - yet. Thats the very issue with steele's case claims. Have never once had it challenged and we use narration "Steeles Case" as granular data goes to ATO. It helps review and avoids escalation as a "review" which can become audit.

 

I was advised by the ATO officer to include it in a rental schedule.

It doesnt cause a validation error. Ive lodged many like that. Maybe handisoft doesnt validate it. But xero tax allows it and it lodges with the ATO.

D15 is also audited as much as a rental schedule with deductions and no income.

The net effect is the same. It is deductible. but ive been guided by discussions directly with the ATO. If different let me know can always put in a complaint form to the ATO.

 

A rental schedule is only required where a domestic property has been rented or is available for use. Otherwise it is not a property producing rental income or available which the instruction specify. Where a property is not available or rented then its a D15 issue. The classification for deductions most correctly falls into D15 if that occurs. D15 deductions may be included in a rental schedule where some income is produced in the year. ie no need to split. For a foreign property a foreign rental worksheet and foreign income.

There may be reasons why a rental shedule is not approriate that include the date first used to produce income. This may be incorrect if the expenses are steeles deductions and there is no income.

I know other software that validate fail where there is no income. Its like D8 fails if there is no dividend income. Or D5 fails if not a employee. Had a client reviewed (former agent) a few years ago just aftre vacant land rules where they used a rental schedule and ATO staff amended the return to move the construction interest deduction and exclude the $1 income the former agent included. They also asked for support for intended rental. No issue tax wise. I did question the issue at the time as it had no revenue basis to make changes and amend but audit staffer said it was the correct basis. I guess there is no fixed and fast rule ?? Agree net effect same. Actually their income fell $1

Bizarrely if a taxpayer has interest and trust and dividend deductions the ATO inst specific as to where the interest and adviser fees etc are claimed. You can claim it all at 13 or at D8 etc I do find it puzzling. but practical.

 

Whether it goes into a rental schedule or D15 will still produce the same result. It is deductible. I think the audit risk is the same in either the rental schedule or D15. The main thing is that it has actually been identified.

if you recall we had a discussion re borrowing costs going into depreciation as it was easy for that person to track. it isnt accurate but it doesnt change the outcome. the main thing was that the amount is correct. in these situations it doesnt bother me too much.

its the same as the cost for obtaining a depreciation schedule. they technically go into D10 but if i saw someone put it into sundry into the rental schedule im not going to have a heart attack.

 

Here is a shot of something from the NTAA

 

This is relevant to be for the last fin year. There is zero chance my accountant will know the correct thing to do. I will show him this. Thank you.

 

The old draft ruling has been finalised as TR2023/3:

https://www.ato.gov.au/law/view/document?LocID="TXR/TR20233/NAT/ATO"&PiT=99991231235958

 

The following example is in the final ruling

Example 6 – interest expense for multiple purposes

27. Giovanna takes out a mortgage to purchase a vacant block of land in September 2019. Giovanna intends to build a house on the land (which she will rent out). Giovanna does not carry on a business. Giovanna takes out a separate loan for the construction of the house. Giovanna will not be able to claim a deduction for her interest expense which relates to acquiring the land until the house is lawfully able to be occupied and leased or available for lease. If a deduction is otherwise available for the construction loan interest expense, Giovanna will not be prevented from deducting the expense by section 26-102.

I think the wording is identical to that in the draft ruling for this example

 

Hi @Terry_w ,

If I debt recycling my PPOR to pay for the Planning and Building Permit, is the interest incurred deductible? We’ve just started the process and plan to start the construction in the next 2-3 years. Do we have to wait until the construction starts to be able to claim deduction on the interest or can we start claiming from now?

Thanks

 

@Terry_w thanks for this thread - Tax agent felt the construction loan interest was not deductible during construction - Pointed them to this thread, they called the ATO and confirmed. Saved me a whole bunch of $$. Thanks again.