Capital Works: construction expenditure area - rental property previously used as display home

Is there a construction expenditure area under section 43-75 of the Income Tax Assessment Act 1997 (ITAA 1997) for capital works constructed by a speculative builder in 1993 if the capital works were first used as a display home by the builder and later purchased by the taxpayer for use as a residential rental property?

Yes. There will be a construction expenditure area under section 43-75 of the ITAA 1997 for the capital works represented by the building.

The construction of the building commenced after 19 August 1992 and was completed by the end of that year. The building was constructed by a speculative builder in the course of carrying on a business that included the construction and sale of buildings of that kind. The building was used by the builder as a display home for several years before being bought by the taxpayer who uses it as a residential rental property to produce assessable income.

For a taxpayer to claim a capital works deduction under section 43-10 of the ITAA 1997, the capital works must have a construction expenditure area.

Subsection 43-75(2) of the ITAA 1997 provides that the construction expenditure area of capital works that commenced before 1 July 1997 is the part of the capital works on which the construction expenditure was incurred that was: • to be owned or leased by the taxpayer; and • at the time of completion of construction, was to be used in the way described for the relevant time period in Table 43-90 of the ITAA 1997.

Table 43-90 of the ITAA 1997 sets out acceptable uses at the time of completion of the capital works. The required use depends upon the type of capital works and the time that they were begun. A display home begun in the time period 19 August 1992 to 30 June 1997 inclusive falls in the category of 'Other buildings'. The relevant acceptable uses for such a building at the time of completion were: (a) use by the entity that incurred the expenditure for the purpose of producing assessable income or exempt income; or (b) disposal by that entity to another entity for use by the other entity for the purpose of producing assessable income or exempt income; or (c) use by an entity wholly or mainly for, or in association with, residential accommodation; or...

The use of the building as a display home by the builder would be for the purpose of producing assessable income. However, Subdivision 43-E of the ITAA 1997 has special rules about uses of capital works. These rules affect the uses of capital works described in Tables 43-90, 43-140 and 43-145 of the ITAA 1997. In particular, section 43-185 of the ITAA 1997 contains rules in relation to buildings used for residential or display purposes.

Subsections 43-185(1) and (2) of the ITAA 1997 do not apply in this case because of the date construction commenced. Subsection 43-185(3) of the ITAA 1997 provides that a building begun after 17 July 1985 and before 1 July 1997 is taken not to be used for the purpose of producing assessable income if it is used mainly for the exhibition or display in connection with the sale of all or part of any building. However the note to subsection 43-185(3) of the ITAA 1997 makes it clear that this affects the current year use table in section 43-140 of the ITAA 1997 and does not apply to the Table of intended use at time of completion of construction in section 43-90 of the ITAA 1997.

The use of the building as a display home has therefore satisfied the requirement about the intended use at the time of completion of construction.

Although the expenditure incurred by a speculative builder in constructing a building would generally be of a revenue rather than capital nature, it does not prevent there being a construction expenditure area in this case. Subsection 43-75(3) of the ITAA 1997 provides that there is taken to be a construction expenditure area for capital works purchased by one entity from another where: • the capital works would have had a construction expenditure area but for the fact the other entity did not incur capital expenditure, and • the parties are not associated, and • the builder constructed the capital works on land it owned or leased in the course of a business that included the construction and sale of such capital works.

This means capital works purchased from a speculative builder may be eligible for a deduction in the hands of the first and subsequent purchasers.

As the requirements of subsections 43-75(2) and (3) of the ITAA 1997 have been satisfied, there is a construction expenditure area for the display home. If all other conditions are met, the taxpayer will be entitled to a capital works deduction under Division 43 of the ITAA 1997.