If you buy vacant land with the aim of building a rental dwelling on it, you can claim tax deductions for expenses such as loan interest and council rates. To be entitled to these deductions, you must build the dwelling in a reasonable period of time and make it available for rent as soon as the dwelling is completed.

In Steele’s Case, the High Court consiered the deductibility of interest expense incurred on borrowings to purchase land intended to be developed for income production. In this case, the interest expenses on borrowed funds used to acquire land that will be solely used in income producing operations. As intention throughout is to build an income producing building and there is no private or domestic purpose for holding the property and the length of time between purchase of the property and commencement of construction is not considered to have been so long that the necessary connection between outgoings and the assessable income is not lost.

Taxation Ruling TR 2000/17, in considering the above decision, concludes that interest incurred in a period prior to the derivation of relevant assessable income will be incurred in gaining or producing the assessable income in the following circumstances:

• The interest is not incurred “too soon”, is not preliminary to the income earning activities and is not a prelude to those activities;

• The interest is not private or domestic;

• The period of interest outgoings prior to the derivation of relevant assessable income is not so long, taking into account the kind of income earning activities involved, that the necessary connection between outgoings and assessable income is lost;

• The interest is incurred with one end in view, the gaining or producing of assessable income;

• Continuing efforts are undertaken in pursuit of that end.

Penalty 'interest' payments

In a case where borrowed funds are lost and there is a penalty imposed upon early repayment of the borrowing, that penalty will be deductible as if it were interest that could not be avoided whether or not it can truly be characterized as interest.

This commentary has been prepared for the purposes of general nformation and guidance only. It should not be used for specific advisor used for formulating decisions under any circumstances. If you would like specific advice about your own personal circumstances please contact ATO or your Tax Agent.