Interest expense - vacant land held for future income producing use

Is interest on a loan, taken out to fund the purchase of vacant land held for future income producing use, deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes, interest on a loan taken out to fund the purchase of vacant land held for future income producing use is deductible under section 8-1 of the ITAA 1997.

The taxpayer borrowed funds and purchased land with the intention of constructing an income producing dwelling. That intention remained constant during the time of the taxpayer's ownership of the property.

The taxpayer incurred interest expenses on the borrowed funds.

For financial reasons, the taxpayer was unable to commence actual development of the property for a four year period.

In that time the taxpayer saved for the construction, viewed display homes, progressed the building design and discussed the concept with colleagues.

Four years after the land was purchased the taxpayer engaged a builder. The property was built over a period of eight months. The house was then let to tenants.

Section 8-1 of the ITAA 1997 provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature.

In Steele v. FC of T (1999) 197 CLR 459; 99 ATC 4242; (1999) 41 ATR 139, the High Court considered the deductibility of interest expenses incurred on borrowings to purchase land intended to be developed for income production. Taxation Ruling TR 2000/17, in considering the above decision, 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, taking into account 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.

In the taxpayer's case, the interest was incurred on borrowed funds used to acquire a property that was solely intended to be used in income earning operations. In these circumstances the interest expense is not considered to have been preliminary or incurred at a point "too soon" before the commencement of the income producing activity.

Furthermore, the taxpayer's intention throughout was to build an income producing building and there was no private or domestic purpose for holding the property. The taxpayer was committed to the project and took steps to develop the property prior to construction by saving money and planning and designing the building. The length of time between purchase of the property and commencement of construction is not considered to have been so long that the necessary connection between the interest outgoings and the assessable income is lost.

In these circumstances the taxpayer is entitled to a deduction for the interest expense under section 8-1 of the ITAA 1997. Note: TR 2000/17 was withdrawn by TR 2000/17W with effect from 9 June 2004 and is replaced by TR 2004/4 which applies to years of income commencing both before and after its date of issue.