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.

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. 

Previously, 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. 

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 for holding costs 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. 

Note however that the ATO recently clarified the position regarding the deductibility of interest borrowed to construct the house. This is not a “holding cost” and is deductible providing the intention is to earn assessable income from the property (for example, rent). So, if you have a mortgage which partly relates to the cost of the land and partly to the cost of building the house, you will need to apportion the interest between non-deductible holding costs (the land) and deductible construction costs (the house).

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 for expenses relating to “holding costs”. 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. 

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.

What do I do now? 

For “mum-and-dad” property investors who intend to build and who often factor in the tax deductions to help finance the project, this will need to be built into budgets to determine the financial viability of small-scale subdivisions and developments. Talk to your tax agent, at H&R Block, for more details.

The views expressed in this article are an opinion only and readers should rely on their independent advice in relation to such matters.