Hello,
Last year we demolished our investment property and started to build two new ones with intention to rent it out. I would like to confirm the right way of how I should claim the interest on the construction loan for new investment properties in the construction year – when there is no income from them yet. Just to clarify I have a separate loan that was used to purchase the original investment property that is used to “hold the land” and I have no intention to claim interest on this loan.
First of all, why I’m allowed to claim interest on construction loan while there is no income yet?
I reference the Draft Taxation Ruling, TR 2021/D5, Income tax: expenses associated with holding vacant land.
Paragraphs 26 to 28 of draft tax ruling TD 2021/D5 say: Loss or outgoing relating to holding land
26. Subsection 26-102(1) clarifies that any interest or borrowing costs to acquire land are included as a cost of holding land. Examples of other costs of holding land include council rates, land taxes and maintenance costs.
27. In the context of section 26-102, we do not consider the costs of constructing a substantial and permanent structure on the land, or any interest or borrowing costs (to the extent they are associated with construction), to be a loss or outgoing related to holding land.
Example 6 - interest expense for multiple purposes
28. Giovanna takes out a mortgage to purchase a vacant block of land in September 2019. Giovanna intends to build a house on the land (which she will rent out). Giovanna does not carry on a business. Giovanna takes out a separate loan for the construction of the house. Giovanna will not be able to claim a deduction for her interest expense which relates to acquiring the land until the house is lawfully able to be occupied and leased or available for lease. If a deduction is otherwise available for the construction loan interest expense, Giovanna will not be prevented from deducting the expense by section 26-102.
As you can see in the examples above, we can’t claim cost of holding land (point 26), but costs of constructions are not considered as land holding costs (point 27) and – construction loan interest is not prevented from deduction (point 28).
Now, the main question is whether to claim them as part of the “Other deductions” (field D15) or claim them as part of the Rental Property Schedule (RPS).
For the first “D15” option, I found that accounts recommend “to add ‘Steeles case’ as the granular info that goes to ATO and it may reduce review issues which can become an audit”. Also reasoning for this field was, that in many cases the commercial software for tax returns might disallow any deductions to be put against the property that had no income in this financial year.
Another accountant provided a second “RPS option” referencing his previous conversation with ATO when “he was advised by the ATO officer to include it in a rental schedule.” And as justification for it, he provided an extract from NTAA publication from 2015, that was saying:
Tax Warning – Claiming interest on the “I” return and RPS for a property not yet rented or available for rent
When interest is being claimed for a rental property that has not been rented to tenants or available for rent, these claims should be made at the rental property labels of the “I” retun (e.g. at item 21 of the 2016 “I” return).
These interest claims should also be reported on the Rental Property Schedule (‘RPS’) (e.g., at label ‘L’ for interest deductions). The ATO has also advised that a date must be entered (e.g. it is mandatory) in the “Date property first earned rental income” field, even though the property may not have yet earned any rental income as at 30 0June of the income year. In this regard, the ATO has advised that the date the property first earned rental income does not have to be in the income year to which the RPS related.
Furthermore, where the property has not yet earned rental income by the time the RPS is lodge with the ATO (together with the taxpayer’s income tax return), the ATO has advised that a future date can be inserted. Even if that future date is not certain, an estimated future date (from which the property is expected to first earn rental income) will need to be recorded (according to the ATO) to ensure that the RPS can be lodged.
Therefore, my question is: what option (D15 or RPS) needs to be used to claim the interest on the loan for the construction of the investment property that hasn’t earned the income in the financial year.
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