Rental Property - deductibility of estimate for cost of actual construction expenditure

Can a taxpayer claim a deduction under sections 8-1, 25-5, 25-25 or Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997) for the cost of obtaining an estimate of the cost of actual construction for the purposes of determining their deduction for capital works under Division 43 of the ITAA 1997 where they have not requested a notice under subsection 262A(4AJA) of the Income Tax Assessment Act 1936 (ITAA 1936) from the transferor of the property?

No, a taxpayer cannot claim a deduction under section 8-1, 25-5, 25-25 or Division 43 of the ITAA 1997 for the cost of obtaining an estimate of the cost of actual construction for the purposes of determining their deduction for capital works under Division 43 of the ITAA 1997 where they have not requested a notice under subsection 262A(4AJA) of the ITAA 1936 from the transferor of the property.

The taxpayer purchased a rental property that is leased under a long-term lease agreement.

A notice, under subsection 262A(4AJA) of the ITAA 1936 detailing information that would enable the taxpayer to work out how Division 43 of the ITAA 1997 will apply to them in respect of capital works, was not requested or obtained from the transferor of the property by the taxpayer.

A report estimating the cost of building the structure was obtained from an appropriately qualified person, such as a clerk of works, a supervising architect, a builder who is experienced in estimating construction costs or a quantity surveyor who has experience in the relevant type of construction, as required by Taxation Ruling TR 97/25.

Subsection 43-50(6) of the ITAA 1997 refers to the special record keeping rules that apply to Division 43 of the ITAA 1997 and are contained in subsection 262A(4AJA) of the ITAA 1936.

Section 262A of the ITAA 1936 outlines the responsibilities of taxpayers in regard to keeping records, including the situation where capital works are the subject of deductions under Division 43 of the ITAA 1997.

Subsection 262A(4AJA) of the ITAA 1936 requires a person (the 'transferor') who is disposing of capital works to give the recipient (the 'transferee') a notice containing information that will allow the transferee to calculate the remaining deductions available to them under Division 43 of the ITAA 1997. The transferee is required to keep a copy of this notice for 5 years after they dispose of the asset. Taxation Ruling TR 97/25 sets out the circumstances where estimates will be accepted in place of a notice of the actual costs of construction for the purposes of Division 43 of the ITAA 1997. A taxpayer needs to request a notice prepared in accordance with subsection 262A(4AJA) of the ITAA 1936. If they are unable to obtain such a notice then an estimate will be accepted.

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.

Estimates of construction costs by an appropriately qualified person do not affect the income producing capacity of an asset. These estimates are carried out in order to determine the cost of building a capital asset. The estimate is directly related to the asset itself. The purpose of obtaining an estimate is to establish the quantum of construction costs. There is insufficient nexus to the gaining or production of assessable income for a deduction to be allowed. The expenditure is too remote.

The costs of obtaining the estimate are therefore not deductible under section 8-1 of the ITAA 1997.

Section 25-25 of the ITAA 1997 allows a deduction for survey and valuation costs where an expense relates to the borrowing of money.

The expense incurred by the taxpayer for the purpose of determining the cost of constructing the building bears no relationship to the borrowing of money and is therefore not deductible under section 25-25 of the ITAA 1997.

Division 43 of the ITAA 1997 allows a deduction for 'construction expenditure'. Section 43-70 provides that the expense is limited to those expenses 'incurred in respect of the construction of capital works'. The completion of construction means that expenses that occur after completion cannot be characterised as 'construction expenditure'. An estimate of the cost of actual construction made after the change of ownership of the asset is not connected to the construction of the asset and is not part of the cost of construction.

The costs of obtaining the estimate are therefore not deductible under Division 43 of the ITAA 1997.

Section 25-5 of the ITAA 1997 allows a deduction where an expense is incurred by the taxpayer in order to manage their tax affairs. This includes the costs of maintaining records for income tax purposes.

Capital expenditure is expressly excluded from being deductible under this section. However, expenditure for this purpose is not necessarily characterised as being 'capital', merely because it relates to matters of a capital nature.

There are circumstances where the transferor is unable to comply with their obligations under subsection 262A(4AJA) of the ITAA 1936. In these circumstances, the transferee will need to create documents or records that will enable them to claim an appropriate deduction. In these situations a taxpayer will be able to claim a deduction in respect of an appropriately qualified person's costs under section 25-5 of the ITAA 1997. The cost incurred has a direct relationship to the management of their tax affairs. It enables them to calculate their claim for a deduction under Division 43 of the ITAA 1997. Without incurring this expenditure they could not do that. However this will only be in situations where a notice under section 262A(4AJA) of the ITAA 1936 cannot be obtained. If the taxpayer has not requested a notice then they will not be able to rely upon an estimate. Only if they are unable to obtain a notice can an estimate be relied upon. The question of whether a notice can be obtained is a question of fact for each individual case.

As the taxpayer has not requested a notice under subsection 262A(4AJA) of the ITAA 1936, the cost of an appropriately qualified person's estimate of construction costs of the rental property is not deductible under section 25-5 of the ITAA 1997.