Mark Chapman on building a new investment property: claiming deductions during construction

If you’ve invested in vacant land with a view to building an investment property on it, the tax deductions you can claim have changed…and not for the better.

What’s changed?

From 1 July 2019, expenses associated with holding vacant land are no longer deductible, even if you already owned the vacant land at that date.

Prior to that date, you could claim tax deductions on vacant land purchased with the intention of building a property to rent.

The sort of deductions that used to be claimable, but no longer are, include so-called “holding” expenses such as loan interest on money borrowed to finance the acquisition of the land and construction of the property, council rates, land tax and insurance. To claim the deduction, it was simply necessary to demonstrate that active and genuine steps had been undertaken to build the dwelling and make it available for rent as soon as it was completed.

Such deductions can no longer be claimed where the expense is incurred from 1 July 2019 onwards.

What does that mean if I’m constructing a new property to rent out after it is built?

Even whilst the rental property is under construction, deductions for holding costs still can’t be claimed. Given that mortgage interest in particular can be a substantial cost during the construction phase, this will have a severe impact on cash flow for some property owners and in some cases the extra costs could make a project financially unviable.

In short, the property is still regarded as vacant land until the property is legally able to be occupied by law (for instance, when an occupancy certificate is issued) AND the property is actively marketed for rent.

In practical terms, deductions aren’t claimable until the finished property is on the market for rent. Even if the building is complete but not currently listed for rental, deductions still can’t be claimed.

The same rule applies to “house and land packages”; until there is a finished property on the block, and it is listed for rent, deductions cannot be claimed.

Is there a way around the rules by claiming that the land is not really vacant?

Sadly not. Although some people would claim that a block of land is not vacant because there is some form of structure on it – such as a garage, a caravan, a shed or even a letter box – the ATO disqualifies such structures. In order not be regarded as vacant for tax purposes, any structure on the land must be substantial, permanent and must have an independent purpose – so a house qualifies (provided it is legally able to be marketed and is being actively advertised for rent!) but a garage, say, does not qualify.

So, there’s no tax relief at all?

There are no immediate deductions. However, holding costs in relation to vacant land can be added to the tax cost base for capital gains tax (CGT) purposes. That will reduce the amount of CGT payable when the property is ultimately disposed of. But that could mean a long delay before property owners get any tax benefit!

Are there any exceptions to the new rules?

Yes. Vacant land held for use in a business is excluded from the restrictions, which will be helpful in particular to farmers and those in the business of property developing. Sadly, most “mum and dad” property investors won’t count. The new rules also don’t apply where the vacant land is owned by a company – the restriction is particularly aimed at individuals and those who own land through a family trust or a self-managed super fund.

I’ve bought a new-build apartment that is uninhabitable because of faulty cladding. It’s now sitting vacant. Am I caught by the new rules?

No. According to the ATO, if you rented out or had an apartment available for rent in a multi-unit development that was found to have significant building faults and deemed uninhabitable, you should not be impacted by the changes and deductions can continue to be claimed as there is still a substantial structure on the land.

Why change the rules?

Well, quite simply the government is concerned that too many people are buying vacant land and then sitting on it for years until it grows in value and can be sold at a sizeable profit. Along the way, they claim to have an intention to build on the land, claim the tax deductions, but then never actually get round to building anything.

Few people would object to stopping people like that claiming deductions, but for “mum-and-dad” property investors who really do intend to build and who often factor in the tax deductions to help finance the project, this is a retrograde step that will need to be built into budgets to determine the financial viability of small-scale subdivisions and developments.

By Mark Chapman, Director of Tax Communications, H&R Block

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