Tax Tip 507: Interest on a Loan Used to Acquire Vacant Land and Cost Base Expenses

Discussion in 'Accounting & Tax' started by Terry_w, 3rd Jul, 2023.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Generally, interest, and other expenses, may not be deductible if it relates to the purchase or holding of vacant residential land. This is due to the change in legislation back in 2019. See s 26-102 ITAA97 and Tax Tip 506: Claiming Interest During Construction Tax Tip 506: Claiming Interest During Construction


    It is possible though that these costs could form part of the cost base expenses for the property and be used to reduce CGT when the property is sold.


    Example

    Homer is a budding property investor and he buys some land on which he plans to build duplexes to hold and rent out. The land cost $1mil and he borrows the lot at 6% pa. Due to a number of factors it is 2 years before the construction is complete and he ends up paying $120,000 in interest during this period – just for the land component.


    This is no longer deductible to Homer but when he sells he can use that as a cost base expense to help reduce his CGT – he might save up to $30,000 on CGT because of this.


    Note that the interest on a loan used to construct may still be deductible. See my other tax tip on this Tax Tip 506.


    The ATO’s position on this can be found in TR 2021/D5

    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

    paragraph 29 which says:

    Third element costs of a CGT asset

    29. The third element of the cost base of a CGT asset is the costs of owning the asset including interest, rates and land taxes.[13] Where section 26-102 prevents a deduction for holding costs, the expenses may form part of the third element costs of owning the asset.
     
  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    This ruling is somewhat confusing to many.

    eg John buys a 1200m2 lot and intends to subdivide and construct a new dwelling on the rear. The subdivision occurs after completion so its a single title initially with a substantial residence that can be occupied and he plans to do that. Thats fine. When he fences off the rear yard for the build its on same title. No vacant land holding period rules. There is a single title with a residence capable of being in use.

    His brother Stuart holds a similar neigbouring property. However, he decides to demo the old house which is otherwise habitable. It is not vacant land and subject to these rules initially but when the demo occurs it becomes vacant land. But if stuart buys the land with a dilapidated house on it this will be subject to the vacant land holding period rules from day one as the dwelling cant be put to use.

    Its wise to ensure there is a tax plan and records of intentions for all developmnet type activities and the vacant land holding period rules are part of this. GST issues also may be involved.
     
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  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Similar to borrowing to build a granny flat on the back on an existing property. I think the interest and other costs could be deductible in that instance as it is not vacant land
     
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  4. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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  5. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Yes. Para 45-48 should be considered which refers to title not a portion of it etc
    Para 49 contrasts where a owner subdivides vacant land to split titles. The test then applies to each lot individually.
    Eg Fred buys a lot that is 2000m2. He proposes to construct two new dwellings and retain the one already there and renovate it. He will subdivide on completion. The fact one dwelling on the single title exists works. ALL holdings costs are deductible. Vacant land rules not applicable provided Fred builds to rent out, NOT sell. However if Fred buys the land and it had a dilapidated house the vacant land rules dont consider it a dwelling but consider the site is vacant land. He cant demo that after building two dwellings as from the start the inhabitable dwelling treats the land as if it was vacant.

    Also a common misunderstood one is the business rule. This doesnt apply to isolated profit making But using a company may bypass that limitation. The company must be the landowner NOT a trust beneficiary etc
     
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  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    What about this example:

    Homer wants to buy a vacant piece of land but owner will only sell if they buy the house/land next door as well, under the same contract - no doubt to get the main residence exemption on both titles - there are 2 separate titles, but used as one block.

    Can Homer claim the interest on the whole loan if he rents out the 2 lots and house under one tenancy agreement?

    I would argue he could.

    What if he intended to build on the second block later and rent that out? I am not sure that would change anything.

    Homer should get his own tax advice and perhaps a private ruling
     
  7. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    I would agree that provided the vacant land is adjacent to the residence then the whole land (even if two titles) is one CGT asset at this point. It is important the lease include access to and use of the vacant land. The adjacent land rule applies for the main residence exemption (eg a tennis court across the street or 100m down the road) BUT its not explicit for investment use. Arguably the vacant land must be used for more than mere additional land under a lease. A example where this fails is agistment. Its not considered income producing use. Use of the vacant land is ideal where its close and adjoining and in use as part of the rental. eg install swings / trampoline etc for kids or grow veggies. . The vacant land lease should really have further income - but how much ? The land could fall foul of vacant land holding period rules too. This would look at each land title. A ruling may be wise. This should address s8-1 and the level of income the vacant land produces as well as the adjacent issues and the lease.

    State land tax rules may also need to consider the title and use.

    If use later changes so that vacant land is held for a new purpose (eg to construct) then the vacant land holding periods rules would apply to that portion and suspend interest , rates and other costs that relate to the LAND. Interest on the build may be deductible throughout the build and after if the intended purpose is to rent the new dwelling to produce income (Steele's case)

    At some point Homer should get a reg valuer to APPORTION the historical cost into two segments when they are used for different purposes.
    1. House and its land
    2. The vacant land.
    This will assist blended costs such as loan interest apportioning or even rates if its one notice etc
     
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  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    house knocked down and planning to do a rebuild, but developer working next door offered to rent the vacant land for a period.
    Interest on the loan was deductible
     
  9. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    The use test looks at the user of the land (business) not just the owner.

    If the vacant land is used in business, deductions for holding costs for the land are not affected by these changes if either:

    • the land is used or available for use in carrying on a business to produce assessable income of
      • you
      • your affiliates or an entity of which you are an affiliate
      • your spouse or child (under 18)
      • an entity connected with you
    • the land is leased at arm's length to another entity and
      • the land is used or available for use in their business and
      • the land does not contain residential premises and no such premises are being constructed on the land.
    Note that the period may end. eg a display village builder leases the land and starts to build a house on the leased land. It may be better that a company own that land.
     
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