B. Sale of a residential rental property and post-cessation interest
Despite the ‘post-cessation interest extension’ contained in S.26-102(1)(b)(ii), which assists in claiming deductions for any ongoing post-cessation interest expenses incurred following the sale of a commercial rental property, there is concern in relation to claiming such expenses following the sale of residential rental properties that are not tenanted nor available for lease, hire or licence at the time of sale. This would be a common scenario, particularly due to a (very understandable) desire to provide ‘vacant possession’ of the property upon sale.
In particular, the additional requirements pertaining to residential premises in S.26-102(4) creates unnecessary and artificially different tax outcomes between:
- taxpayers who have constructed (or substantially renovated) their residential rental properties whilst they held the land (irrespective of when the taxpayer constructed or substantially renovated the property while they held the land); and
- taxpayers who have purchased and rented pre-existing or ‘second hand’ residential rental properties (and who did not substantially renovate the premises whilst they held the land).
For example, where a taxpayer owns a residential rental property that they constructed or substantially renovated, S.26-102(4) will potentially treat the property as ‘vacant land’ if the property is provided with vacant possession and is not ‘available for rent’ at the time of sale. As such, this could mean that the ‘post-cessation interest extension’ in S.26-102(1)(b)(ii) will not be applicable (as the land will be considered ‘vacant land’ just prior to sale) and any ongoing otherwise deductible post-cessation interest deductions will be denied.
In contrast, a taxpayer who purchased a pre-existing residential rental property (which they did not substantially renovate) will not attract the operation of S.26-102(4), meaning they can rely on the S.26-102(1)(b)(ii) ‘post-cessation interest extension’ and potentially claim ongoing (post-cessation) interest deductions if the property is vacant and not ‘available for rent’ at the time of sale.
Example– Post-cessation interest for residential rental property
Bettina purchased a vacant block of land in 2016 and constructed a residential property which she subsequently rented out. In June 2019 the tenant moved out of the property, prompting Bettina to put the property up for sale in July 2019 (i.e., the 2020 income year). Bettina wanted to market the property with staged furniture and offer it with vacant possession. As a result, she did not actively seek another tenant during the sales period.
Unfortunately, Bettina sold the property for less than what she originally borrowed, resulting in a loan shortfall and an ongoing obligation to pay post-cessation interest on the shortfall.
Can Bettina claim a deduction for the post-cessation interest?
Arguably not. As Bettina constructed the residential premises while she held the land, S.26-102(4) potentially operates so as to deem the property as ‘vacant land’ for the purposes of S.26-102 for any period the property is not rented or at least available for rent.
As a result, the ‘post-cessation interest extension’ contained in S.26-102(1)(b)(ii) will not apply as the property will be treated as vacant just before Bettina sold the property (i.e., as it was not available for rent). This means any otherwise deductible holding costs, including the post-cessation interest, will not be deductible.
What if Bettina had purchased a pre-existing residential rental property?
In this instance, S.26-102(4) would not apply to deem the residential property as ‘vacant land’ and Bettina could claim a deduction for any ongoing post-cessation interest, assuming the requirements of TR 2004/4 were otherwise satisfied and the property was not substantially renovated while Bettina held the property.