Vacant land tax deduction changes are designed to target the everyday 'property development' including the building of a rental property.
Do you hold a vacant block of land? Are you intending to build an investment property or some income-producing development on the vacant land? You need to be aware of a new law that has been passed, effective 1 July 2019, to deny a tax deduction for the holding costs and financing costs associated with vacant land.
What are vacant land holding costs?
Prior to the passing of this law, if you purchased vacant land with the intention of building a rental property on it, you would have been able to claim a tax deduction for the costs of holding the land. This included expenses such as:
- loan interest
- council rates
- land tax
- maintenance costs
- other recurring holding costs
But with the new laws that are effective from 1 July 2019, tax deductions for these expenses are no longer available, and could impact the way you prepare your 2020 rental property tax return.
However it would appear that the changes do not prevent you claiming a tax deduction for one-off borrowing costs such as loan establishment fees which are tax deductible over five years.
What is the new law regarding rental property holding costs?
Legislation was passed through Parliament in late 2019 to put an end to taxpayers claiming a tax deduction for expenses related to holding vacant land. This means that you can no longer claim a deduction in your rental property tax return for any loan interest, council rates, land tax, insurance, maintenance or other holding costs.
The change of law is retrospective. This means that even if you held the vacant land before 1 July 2019 you're no longer eligible for the holding cost tax deductions.
Interestingly, the law will also apply to land that's not entirely vacant, which means that if you own land with a building on it that's not considered to be 'substantial' then you're property will likely be treated as vacant land and the tax deductions for holding costs will be denied.
What is vacant land? And what is a substantial building?
Vacant land is broadly defined as "land with no substantial and permanent structure on it that is in use or available for use".
What is meant by 'substantial building' is a slightly grey area. The legislation does not clearly define what substantial means for this purpose of holding cost tax deductions. From reading the Bill it would suggest that a silo or a shearing shed is a substantial building, but a domestic shed or garage would not pass the test.
Which taxpayers are affected by the new law?
The application of the new law affecting vacant land really depends on what type of taxpayer you are.
The laws are very clearly targeting the everyday 'mum and dad' rental property developer, or anyone looking to build a rental property on vacant land held in their own name, that of a trust or a SMSF.
However, these new laws do not apply to you if you hold vacant land, or land with unsubstantial buildings, in a company. The laws are not applicable to non-self-manged superannuation funds, public trust and managed investment trusts.You'll also be unaffected by the new laws if your vacant land is used in the carrying on of your business. This means that if you're an individual or entity that is, for example, undertaking a development of high-rise apartments or any form of significant property development that amounts to carrying on a business, then you are not denied a tax deduction for holding costs.
But, be careful when classifying your development as a business versus a profit-making venture. The latter is not a business. We recommend you seek our professional tax advice if you're uncertain of how the ATO would categorise your property development project or undertaking.
Practical examples of how the law applies.
Tax deductions for the expenses mentioned earlier are no longer available for the period of time that land is considered to be “vacant land”.
Let's assume you purchase a vacant block of land, either personally or in your family trust with the intention of building a new house on it to rent out. The loan interest, council rates and other expenses that you incur during the period up to when you obtain 'notice of completion' are no longer tax deductible.
Another example is where you demolish an existing investment property in order to subdivide the property. You construct four units and sell them upon completion. This type of undertaking will likely be viewed as a profit-making venture, rather than a business. For this reason the business exception won’t apply. Any holding costs incurred during the time between demolition and obtaining notice of completion for the units will not be tax deductible because the property will be deemed vacant land.
Is there any way to recoup holding costs on vacant land?
Yes, there is still an opportunity to salvage the holding costs that the new laws have otherwise denied a tax deduction for. The holding costs, rather than being tax deductible in the year they’re incurred, will now be added to the cost base of the property. This will, in turn, reduce any capital gain arising on the sale of the property.
It’s important to note though, that where the gain qualifies for the 50% general discount, the tax saving from those costs is essentially halved, and it could be several years before you get to recover the benefit of the costs.
Is it time to explore a different legal structure for tax purposes?
Most likely yes. As experienced accountants in Melbourne, we always recommend a regular review of your property legal structure or business legal structure for tax planning purposes as well as asset protection.
Tax laws are ever evolving and in most cases, you will need to be aware of changes in law before they are enacted.
This will allow adequate time for you to make the necessary changes to your legal or business structure and ensure that you don’t miss out on critical tax planning opportunities.
If you have concerns about your rental property or property development legal structure, please contact our office to speak with our Melbourne Accountants at our Melton office (03) 9746 6479.