Deduction - Legal expenses incurred in taking court action for loss of rental income

Is a taxpayer entitled to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred for unsuccessful legal action taken to recover lost rental income?

Yes. A taxpayer is entitled to claim a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred for unsuccessful legal action to recover lost rental income.

The taxpayer has a rental property. The property was unable to be leased for a substantial period due to the actions of a third party.

The taxpayer took legal action against the third party to recover lost rental income.

The taxpayer was unsuccessful and was ordered by the court to pay the legal costs of the other party as well as their own costs.

Section 8-1 of the ITAA 1997 states that you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing assessable income and is not: • Capital, private or domestic in nature • Incurred in gaining or producing exempt income, or • Prohibited by a section of the ITAA 1997 or the Income Tax Assessment Act 1936.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Income from rental property is considered ordinary income.

The nature or character of legal expenses follows the advantage which was sought to be gained by incurring the legal expenses ( Hallstroms Pty. Ltd. v. Federal Commissioner of Taxation ( 1946) 72 CLR 634).

The taxpayer was seeking to recover lost rental income. The nature of the advantage sought by the taxpayer was to gain assessable income. Thus, any compensation received in respect of the lost income would be income under ordinary concepts and included in the taxpayer's assessable income under subsection 6-5(2) of the ITAA 1997.

Accordingly, the taxpayer incurred legal expenses for the purposes of gaining or producing assessable income. The taxpayer may claim a deduction for the expenses under section 8-1 of the ITAA 1997.