The Government already announced, as part of the 2018-19 Federal Budget in May, that it will decrease the scope of allowable deductions for expenses stemming from holding vacant land that is intended to be used for residential or commercial purposes. The measure will apply from 1 July 2019. (See page 42 of the federal budget paper.)
The announcement was couched as an integrity measure to address concerns that deductions are being improperly claimed for expenses, such as interest costs, related to holding vacant land, especially where this land is not being “genuinely held” for the purpose of earning assessable income. It is also intended to reduce the tax incentives for “land banking”, which can limit the availability of land for housing or other developments.
While deductions will be disallowed for holding costs associated with vacant land, such as interest, land tax and council rates, there will be two exclusions. These will be for:
- after a property has been constructed on the land, has received approval to be occupied and is available for rent, or
- the land is being used to carry on a business, including a business of primary production.
The “carrying on a business” exception, as noted above, will generally exclude land held for commercial development by those in the business of property development.
Deductions that are denied under this measure will not be able to be carried forward for use in later income years. Under the change, expenses for which deductions will be denied that would ordinarily be a cost base element (such as borrowing expenses and council rates) may be included in the cost base of the asset for CGT purposes when the property is sold. Therefore it follows that expenses that would not ordinarily be a cost base element would not be able to be included in the cost base.
Concerns have been raised that the new measure could have a significant impact on taxpayers undertaking development as property investors. It is perceived that investors who hold land for longer-term development are likely to be denied deductions for expenses incurred while such development is in the planning and building phases.
Given that this can stretch out for months or even years between obtaining approval and completing the development, this could result in quite significant strains on cash flow for these investors. So it's important to be mindful of this change if you plan to build a rental property.
Note that as of the date of this article, the Tax Office website still informs taxpayers that there are tax deductions available for expenses of holding land upon which you intend to build a dwelling to rent. Do not rely on this information - the law is changing.
Taxpayers that are in the business of property development may seem to have dodged a bullet due to the “carrying on a business” exception. Some tax experts have noted however that property developers can be in the habit of using separate entities to hold the land, with the development itself perhaps being undertaken by another entity.
In these situations, the separate entity may not be carrying on a business in its own right. It is therefore unclear at this stage how the new measures may or may not apply in these situations.
Please contact us for further information or advice.