This article is from the Australian Property Journal archive
The Administrative Appeal Tribunal has allowed a deduction for an owner of an investment property that was never tenanted because his intent was to generate rental income, according to chartered accounting and advisory firm, BDO.
Tax deductions can be claimed for an outgoing incurred in relation to a rental property depending on the intent of the owner.
Relevant issues that determine deductibility include, but are not limited to, whether the outgoing is capital in nature, incurred “too soon” in the income earning process or is an “initial repair.
The existence of any of these factors will usually mean an outgoing is not deductible outright but may be added to the cost base of the rental property or capitalized and depreciated.
Some of these factors were considered in Ormiston and Commissioner of Taxation where the Tribunal found that interest and other recurring costs were deductible to the taxpayer, even though the property had never been rented out.
The taxpayer bought a fully geared investment property in 1998. Before he rented out the property he spoke to a real estate agent who said that if some “cosmetic improvements” were made to the property the rental income for the property could increase by as much as $50 per week.
The taxpayer began working on the property and then decided it would be prudent to renovate the house. This took up considerable time and prolonged the other improvements being undertaken on the property. He was also undertaking most of the work himself on weekends and evenings.
Little work was done on the property during 2001 and 2002 as during this time his relationship with his defacto deteriorated and they separated in 2001. The rental property was sold in August 2003 due to legal action following the separation, having never been rented out.
The Commissioner argued that the dominant intention of the taxpayer in incurring interest and other costs was to protect the capital value of the property and also to allow him to indulge his hobby of home renovation.
The taxpayer submitted that his intention all along was to get the property into a fit state to rent out and generate rental income.
The Tribunal examined the intentions of the taxpayer closely and decided, on balance, that his intention was ultimately to use the property for income producing activities.
One of the factors that the Tribunal considered carefully was that the property was fully geared.
The Tribunal could see no reason why the property would be fully geared if only to allow a hobby of home renovation, rather this fact pointed towards the intention of the taxpayer to rent the property out and derive income from it.
This provides some guidance for taxpayers, allowing them to point to the financing of a property as evidence to support an income-producing intention.
The Tribunal found that the interest and other recurring costs (land tax, rates, water charges and insurance) were deductible but depreciation, sundry expenses and repairs and maintenance were not deductible.
The particular legislative sections concerning these deductions required that the property was actually being used for income producing activities.
In this case the judge thought the decision of deductibility of the recurring costs was very much in the balance.
What it came down to in the end was the taxpayer’s intention and how he was able to express and prove that intention.
Documentation of intention at the beginning of a venture can assist further down the track, although documentation of intention alone is not always enough.
If there are any doubts about tax deductibility in an investment property it is always prudent to seek professional advice.
By Nick Gangemi, national tax technical director at BDO.*
