Why this matters

When you build an investment property, the largest cost in the early months is usually loan interest. It runs while there is no tenant, no rent and no income at all. Most investors assume that interest simply disappears into the cost base for a future capital gains tax calculation until the day a tenant moves in.

It is not always that simple. The tax law draws an important distinction between the interest on money borrowed to hold the land and the interest on money borrowed to construct the building. The two are treated differently, and the difference rests on Taxation Ruling TR 2023/3, issued by the Commissioner of Taxation on 27 September 2023, read together with a long-standing High Court principle. Getting the distinction right, and keeping the records to support it, can mean part of the construction interest is deductible in the year it is incurred rather than locked in the cost base for years.

This article walks through the Ruling itself, paragraph by paragraph, so that you can take a clear, referenced interpretation to your accountant. It is general information to help you ask the right questions. It is not advice, and none of it should be acted on until your accountant has confirmed it against your own circumstances.

The starting point: the vacant land rules

Section 26-102 of the Income Tax Assessment Act 1997 was inserted by the Treasury Laws Amendment (2019 Tax Integrity and Other Measures No. 1) Act 2019, which received royal assent on 28 October 2019 and applies to costs incurred on or after 1 July 2019, even where the land was held before that date. TR 2023/3 confirms this at paragraph 55.

Broadly, subsection 26-102(1) denies deductions for the costs of holding land on which there is no substantial and permanent structure in use or available for use. Paragraph 24 of the Ruling confirms that interest and ongoing borrowing costs to acquire the land are holding costs, alongside council rates, land tax and maintenance.

For anyone building, the harder edge sits in subsection 26-102(4), explained at paragraphs 20 to 22 of the Ruling. Residential premises you construct or substantially renovate are disregarded as a substantial and permanent structure until two conditions are both met, and they must remain met throughout your ownership period:

Read on its own, that looks like bad news for every build. While the block sits there mid-construction, the land is vacant for these purposes and the interest on the land loan is denied. Example 5 of the Ruling, at paragraph 23, shows the flip side of the timing: holding costs stop being denied from the date the completed home is lawfully occupiable and listed for lease.

The distinction the Ruling draws

Here is where a first reading of the section misleads. The vacant land rule applies to the cost of holding land. Paragraph 26 of the Ruling takes a different direction for the cost of building on it:

In the context of section 26-102, we do not consider the costs of repairing, renovating, or constructing a structure on the land, or any interest or borrowing costs (to the extent they are associated with repairs, renovation or construction), to be a loss or outgoing related to holding land.TR 2023/3, paragraph 26

In other words, construction loan interest falls outside section 26-102 altogether. It is not a holding cost, so the vacant land rule never reaches it. The land loan and the construction loan are answering two different questions under two different provisions.

Example 6: the Ruling illustrates it directly

The Ruling puts the exact two-loan scenario most investors use into Example 6, at paragraph 27:

Giovanna takes out a mortgage to purchase a vacant block of land in September 2019. Giovanna intends to build a house on the land (which she will rent out). Giovanna does not carry on a business. Giovanna takes out a separate loan for the construction of the house. Giovanna will not be able to claim a deduction for her interest expense which relates to acquiring the land until the house is lawfully able to be occupied and leased or available for lease. If a deduction is otherwise available for the construction loan interest expense, Giovanna will not be prevented from deducting the expense by section 26-102.TR 2023/3, Example 6, paragraph 27

The land interest waits until the home can be occupied and is available for lease. The construction interest is not caught by the vacant land rule at all. Two separate questions, two separate answers.

The catch: not denied is not the same as deductible

This is the point where the popular version of this strategy goes wrong, and where your accountant earns their fee. Look carefully at the wording of Example 6: if a deduction is otherwise available for the construction loan interest, section 26-102 will not prevent it. Those words are doing a great deal of work.

The Ruling itself flags this at paragraph 3. Section 26-102 only ever applies to amounts that would already be deductible under section 8-1 or another provision, and TR 2023/3 expressly does not provide advice on section 8-1. So clearing the vacant land rule is only half the test. The construction interest still has to qualify as deductible in its own right.

For interest incurred before any rent is earned, that question is governed by the High Court’s decision in Steele v Deputy Commissioner of Taxation (1999) 197 CLR 459 and the Commissioner’s position in Taxation Ruling TR 2004/4, which TR 2023/3 itself points to at paragraph 28. The principle is that interest incurred before income is earned can still be deductible provided there is a genuine and continuing intention to use the property to produce assessable income, the interest is not incurred too soon or merely preliminary to the income-earning activity, and the build proceeds within an appropriate timeframe without undue delay.

The contrast case discussed in TR 2004/4 is Temelli v Federal Commissioner of Taxation, where land was held for years without a firm commitment to build. The delay left open the possibility the land was held for another purpose, the connection to future income was broken and the interest was not deductible.

So the construction interest is deductible only where a real, committed, income-producing purpose can be demonstrated: genuinely building to rent, actively progressing the build and able to show it. An intention that is vague, stalled or contingent will not satisfy section 8-1, and the fact that section 26-102 does not separately deny the interest will not save it.

Two worked examples: the same distinction, two timeframes

To show why the construction phase matters, here are two simplified examples drawn from ASPIRE Property Investment Funding Analysis (PIFA) models. Each isolates the interest on the construction loan only, drawn down progressively across the building progress claims from site start to practical completion. It is separate from the interest on the land loan, which is the larger figure the vacant land rule denies during the build. The numbers are rounded and illustrative. They are not projections, not advice and not a guarantee.

The WA contract is smaller and the rate is lower, yet the construction interest is nearly double. The reason is time. A longer build means each progress draw accrues interest for longer, which makes correctly identifying the construction component all the more valuable. The PIFA itself forms part of the evidence trail: it documents a committed intention to build and rent, the build contract, the staged drawdown schedule and the timeline, which is exactly the material that supports the income-producing purpose the law requires. Whether any particular amount is deductible in your case is a question for your accountant.

What happens to the denied land interest

The land loan interest denied during construction is not simply lost. Paragraph 25 of TR 2023/3 confirms that where section 26-102 prevents a deduction, those amounts may form part of the third element of the cost base of the asset under the capital gains tax rules in Division 110. That can reduce a future capital gain, though the third element only assists where there is a gain on sale, not a loss.

There is one more point worth noting for completeness. In Example 7 of the Ruling, at paragraph 34, the Commissioner confirms that interest associated with construction is not a cost of holding land even after the property is sold, and can remain deductible where it continues to be incurred and satisfies TR 2004/4. The construction carve-out is structural, not a timing concession.

How to report it

For self-lodgers, rental interest is claimed in the rental property section of the return under the interest on loans expense type, and the ATO’s rental expenses guidance stresses claiming each expense under the correct type. In practice, almost anyone running this kind of build should be lodging through a registered tax agent. The apportionment between land and construction interest, the timing of when each becomes deductible and the cost base treatment of denied amounts are exactly the details that benefit from professional preparation.

How to stay compliant

Three things matter more than anything else here, and all three are about evidence.

Where this leaves us

The law here is settled and public. The difference in outcome comes down to how the arrangement is structured and documented, which is a planning decision made at the start, not at tax time. The investor who sets up separate land and construction lending, builds without undue delay and keeps clean records is positioned to treat the construction interest correctly and add the denied land interest to the cost base. The investor who funds everything through one account and lets the project drift may lose the benefit of the distinction entirely, even though the same law was available to both.

Whether the construction interest is deductible in your case turns on your intention, your timeline, your loan structure and your records. Every one of those is a question for your accountant and registered tax agent. As your property investment advisor, an ASPIRE Accredited Advisor can help you understand the strategy, structure the project sensibly from the outset and model the outcome through our research and acquisition support. The deductibility, reporting and compliance decisions sit with your accountant.