Do you claim tax deductions on vacant land you own? An unwelcome surprise for property investors from 1 July 2019
In a Bill currently before Parliament, property investors will be denied deductions for holding and financing costs incurred in owning vacant land. Ordinarily, such costs would be deductible where the land is intended to be used for the purpose of producing assessable income.
Under the Treasury Laws Amendment (2019 Tax Integrity and Other Measures No.1) Bill 2019, such costs (eg borrowing expenses, council rates, land tax and maintenance costs) will not be deductible from 1 July 2019, to the extent that the landowner does not hold the land as part of their business.
Landowners who hold the land as part of their business, such as property developers and primary producers, are excluded from the new measures and can continue to claim such deductions in the usual course. Landholders who do not conduct a business in their own right will also be afforded relief if they lease the vacant land to related entities for use in their business.
The restriction was initially announced in the 2018-19 Federal Budget as an 'integrity measure' to address concerns that deductions were being improperly claimed when land was not genuinely held for the purpose of earning assessable income.
One-off developments targeted
Property investors who are undertaking a one-off development, which alone does not constitute a 'business', will be denied deductions until the land contains residential premises that are being leased, hired or licenced or made available for such purposes.
This means not only that investors cannot claim deductions at all during the construction phase of a development, but additionally they are only able to commence claiming deductions once they can demonstrate that they are actively marketing the residential property for lease.
What is 'vacant land'?
Land is considered 'vacant' if there is no substantial and permanent building or other structure that is in use, or available for use, with an independent purpose that is not incidental to the purpose of another structure.
For example, the explanatory material states that a residential garage or shed is constructed for the purpose of adding utility for individuals using the residence on the land. Such structures do not have an independent purpose and are incidental to the residential premises. In contrast, a commercial parking garage complex, a woolshed for shearing and baling wool and a grain silo would all usually have an independent purpose.
There is a low threshold regarding the type of buildings that must be on the land to ensure the land is not 'vacant land.' The building or structure must be substantial and permanent. To be substantial, the building must be significant in size or value. The explanatory material has helpfully clarified, possibly due to anticipated crafty legal arguments, that a letterbox would not be substantial for these purposes.
Denied deductions will be included in cost base
Costs that are not deductible in the construction stages of a one-off development cannot be deducted in later years; there is no ability to 'carry forward' such costs to the point in time when the property is being used for income-generating purposes.
Instead, these costs may be included in the cost base of the asset for capital gains tax purposes, which will provide relief to taxpayers due to a reduced capital gain when they subsequently sell the property.
It is essential that taxpayers retain records of their holding and financing costs once they acquire vacant land, in order to later substantiate the cost base they have calculated upon a disposal. Such records may cover several years, given the likelihood of construction delays until the land contains residential property which is marketed for occupation.
The new measures will significantly impact the cash flow of property investors who obtain financing to undertake one-off property developments. Such investors may need to consider the need to access greater capital before proceeding in such a development.
The measures will apply from 1 July 2019, regardless of whether the land was held prior to this date. We can assist property investors in ascertaining the correct treatment of their holding costs – whether they are entitled to continue claiming deductions or alternatively allocate those costs to the cost base.
The rules will not apply to companies, non-self-managed superannuation funds, public unit trusts, managed investment trusts, and partnerships of these entities. We can assist you in examining structuring options that would best suit your circumstances.
If you own vacant land which you lease to an unrelated party for their business activities, deduction of your expenses will be denied. We can work with you to consider your options in this situation, including whether the rent payable may be increased to offset against your reduced cash flow due to the denial of deductions.
Are you overpaying land tax?
Mondaq Comparative Guide to Trademarks 2019
Rigby Cooke Lawyers' Tax & Wealth and Wills & Estates expertise recognised