Potentially Yes
Investors building a new rental property often assume that none of their interest expenses can be claimed until construction is complete and the property is advertised for tenants.
That is not necessarily the case.
Australia’s vacant-land provisions generally deny deductions for interest and other costs associated with acquiring and holding vacant land. However, interest incurred on borrowings used directly to fund the construction of a future rental property may still be deductible during the building period.
The distinction between the land loan and the construction loan can have an important effect on both the investor’s tax deductions and cash flow.
The vacant-land rules
Section 26-102 of the Income Tax Assessment Act 1997 applies to relevant expenses incurred from 1 July 2019.
Broadly, it denies deductions for losses and outgoings relating to holding vacant land. For an individual investor or ordinary family trust, affected expenses may include:
- interest and ongoing borrowing costs associated with acquiring the land;
- council rates;
- land tax;
- insurance;
- maintenance costs; and
- other recurring expenses of retaining the vacant site.
For a newly constructed residential property, the land will generally continue to be affected by the vacant-land rules until the dwelling:
- can lawfully be occupied; and
- is leased or genuinely available for lease.
Starting construction does not, by itself, cause the vacant-land restrictions to end.
The legislation contains exceptions for certain entities and situations, including some corporate tax entities, managed investment trusts, public unit trusts, qualifying superannuation funds and land used in carrying on a business. However, these exceptions will not usually apply to an ordinary couple passively investing in a residential rental property.
The important distinction under TR 2023/3
The ATO explains its interpretation of section 26-102 in Taxation Ruling TR 2023/3: Income tax—expenses associated with holding vacant land.
The ruling distinguishes between:
- expenses incurred in acquiring or holding the land; and
- expenses associated with constructing or substantially renovating a structure on the land.
Paragraph 26 of TR 2023/3 identifies interest and ongoing borrowing costs incurred to acquire land as expenses relating to holding that land.
Paragraph 27 then explains that expenditure on constructing or substantially renovating a structure is not ordinarily an expense of holding land. Interest and borrowing costs are treated similarly to the extent they are associated with the construction work.
The practical outcome is that:
- interest on a loan used to purchase the land is generally denied during construction; but
- interest on funds used directly to construct the future rental property may fall outside section 26-102.
This is not an automatic deduction. It means only that the vacant-land provision does not block the construction interest. The interest must still be deductible under the general deduction provision in section 8-1.
The ATO’s vacant-land guidance illustrates the same distinction: an investor may claim interest on a construction loan but not interest on the initial loan used to purchase the vacant land, because construction-related interest is not considered a cost of holding the land.
Can interest be claimed before rental income begins?
Potentially, yes.
The High Court’s decision in Steele v Deputy Commissioner of Taxation and the ATO’s Taxation Ruling TR 2004/4 recognise that interest incurred before assessable income begins can still be deductible.
There must be a sufficient connection between the interest expense and the intended future production of rental income.
The deduction is more likely to be available where:
- the completed property is genuinely intended to be rented;
- the construction project is actively progressing;
- the period before rental income starts is not excessively long;
- the borrowed funds are used only for the income-producing project;
- the investor continues taking practical steps towards completion; and
- the rental project has not been abandoned or redirected to private occupation.
TR 2004/4 remains the ATO’s ruling dealing with interest incurred before income-earning activities commence.
Example: John and Mary’s investment property
John and Mary purchase a house-and-land investment property.
The arrangement comprises:
- land costing $350,000; and
- construction of the rental dwelling costing $400,000.
Their finance is maintained through two separate facilities:
- a land loan used exclusively to purchase the land; and
- a construction loan progressively drawn down to pay the builder.
Construction begins in February 2026 and is expected to be completed in February 2027. Once complete and lawfully occupiable, John and Mary intend to appoint a property manager and advertise the property for rent at market rates.
By 30 June 2026:
- $150,000 has been drawn from the construction facility;
- $4,500 of interest has been incurred on the construction borrowings;
- interest has also been incurred on the land loan; and
- John and Mary have paid council rates and other land-holding expenses.
What should be claimed in the 2026 tax return?
The 2026 income year covers the period from 1 July 2025 to 30 June 2026.
Construction-loan interest
Subject to the section 8-1 and TR 2004/4 requirements, the $4,500 construction-loan interest may be claimed.
The funds have been progressively drawn down and applied directly to builder progress claims for a property genuinely intended to produce rental income.
If John and Mary own the property equally as joint tenants, the deduction would generally be divided according to their legal ownership interests. Each would therefore claim their respective share of the deductible interest.
The amount should generally be recorded as interest associated with the prospective rental property in the relevant rental-property section of their returns, supported by the accountant’s working papers explaining why the property produced no rent during the year.
The 2026 ATO rental-property guidance and myTax instructions should be followed when preparing the returns.
Land-loan interest
Interest incurred on the loan used to acquire the $350,000 land component would generally not be claimed as an immediate deduction during the construction period.
It is an expense associated with acquiring and holding land that remains subject to section 26-102.
The deduction may become available prospectively once the completed dwelling can lawfully be occupied and is leased or genuinely available for lease. Interest denied in earlier years does not become deductible retrospectively when the property is completed.
Council rates, land tax and maintenance
Council rates, land tax and ordinary maintenance costs associated with holding the site will also generally be denied during construction.
They should not be included as current rental deductions unless a specific section 26-102 exception applies.
Capital works deductions
John and Mary cannot claim Division 43 capital-works deductions while the building is under construction.
Capital-works deductions generally commence only when construction is complete and the property is first used, or genuinely available for use, to produce assessable income.
A quantity surveyor’s tax-depreciation schedule should be obtained once the final construction costs and completion date are known.
Borrowing expenses
Loan-establishment fees and other qualifying borrowing expenses require separate analysis under section 25-25.
Borrowing expenses associated with the construction facility may potentially be deductible over five years or the loan term, whichever is shorter, but their treatment should not be assumed to follow the interest automatically.
Borrowing costs attributable to the land loan may also be affected by section 26-102 while the land remains vacant.
Are the denied costs lost forever?
Not necessarily.
Non-deductible land-loan interest, council rates, land tax and certain other ownership costs may potentially be included in the third element of the property’s CGT cost base.
If eligible, these amounts can reduce the capital gain when John and Mary eventually sell the property.
Cost-base treatment is not automatic. The expenses must satisfy the CGT cost-base rules, must not have been deducted, and must not remain deductible through an amendment of an earlier return.
Third-element ownership costs also generally do not form part of the reduced cost base when calculating a capital loss.
John and Mary should therefore retain a separate cost-base register recording:
- denied land-loan interest;
- council rates;
- land tax;
- relevant insurance costs;
- maintenance expenses; and
- supporting invoices and loan statements.
Will claiming $4,500 with no rental income trigger an ATO audit?
A construction-interest deduction in a year with no rental income may attract attention, but it should not be stated as certain that the claim will trigger an audit or automated alert.
The ATO does not publicly disclose every risk rule used in its case-selection systems.
A return showing rental expenses and no rental income may reasonably prompt the ATO to ask:
- whether the property was genuinely intended to produce rent;
- whether it was still vacant land;
- what the borrowed money was used for;
- whether the claimed interest related to the land or construction;
- whether the project was actively progressing; and
- whether any private use was intended.
That does not mean the deduction is incorrect.
A properly supported construction-interest claim that accords with TR 2023/3, TR 2004/4 and section 8-1 should be capable of explanation if reviewed.
The ATO continues to publish detailed guidance for rental-property owners, including guidance on vacant-land deductions and the tracing of interest expenses.
How John and Mary can make an ATO review less stressful
The best protection is an audit-ready file prepared while construction is underway—not years later when records may be difficult to locate.
John and Mary should retain the following.
Separate loan records
They should keep the land loan and construction facility in separate accounts.
Separate facilities are not an absolute legal requirement, but they make it much easier to demonstrate which interest relates to construction and which relates to holding the land.
Builder invoices and drawdowns
Each construction drawdown should be matched to:
- the builder’s progress claim;
- the relevant invoice;
- the loan drawdown confirmation; and
- the payment from the facility.
This creates a clear tracing trail from the borrowed funds to the construction expenditure.
Evidence of rental intention
John and Mary should retain evidence that the completed property was always intended to be rented, including:
- the investment strategy or adviser correspondence;
- rental appraisals;
- communications with prospective property managers;
- loan applications describing the investment purpose;
- building plans suitable for rental use; and
- an agency appointment or proposed marketing plan as completion approaches.
Evidence that construction remained active
They should retain:
- the signed building contract;
- approvals and permits;
- construction schedules;
- site reports;
- correspondence with the builder;
- variation documents; and
- explanations for any delays.
If the builder becomes insolvent or construction is otherwise delayed, evidence should show the steps taken to keep the project moving.
Accountant working papers
The accountant’s file should clearly reconcile:
- total interest on the land loan;
- total interest on the construction facility;
- progressive construction drawdowns;
- deductible construction interest;
- denied holding costs;
- each owner’s share; and
- amounts transferred to the CGT cost-base register.
A short technical position paper referencing section 8-1, section 26-102, TR 2023/3 and TR 2004/4 can also be retained with the tax-return workpapers.
The planning opportunity
The John and Mary example demonstrates why loan structure should be reviewed before the land settles and before construction finance is drawn.
Combining land, construction and private expenditure in one mixed facility can make the interest calculation significantly more difficult. It may also expose the investor to unnecessary disputes over tracing and apportionment.
A properly structured arrangement may allow investors to:
- claim eligible construction interest during the building period;
- keep denied land-holding costs separate;
- preserve potential CGT cost-base amounts;
- simplify their annual tax returns; and
- respond efficiently if the ATO asks for supporting evidence.
Building an investment property?
Before signing construction finance documents or making the first builder drawdown, speak with a property tax adviser.
We can review the ownership and lending structure, assess whether construction-period interest may be deductible, establish an audit-ready documentation process and ensure denied holding costs are recorded for potential future CGT use.
Contact our property tax team before construction begins to make sure your finance structure supports—not undermines—your tax position.
This article contains general information only and does not constitute tax, legal, financial or credit advice. The tax treatment depends on the ownership structure, the identity of the borrower, the use of the borrowed funds, the loan documentation and the facts of the construction project.
Q1: If my land loan interest is denied under Section 26-102, can I claim it once the property is rented?
- No. You cannot retrospectively claim back-dated interest from the construction period [TR 2023/3].
- Future Claims: You can only deduct interest incurred after the property is completed and genuinely available for rent.
- The Silver Lining: All denied holding costs are safely added to your property’s CGT cost base to lower future selling taxes.
Q2: What if the construction delays are the builder’s fault? Can I claim land interest then?
- No. The ATO does not grant extensions or exceptions for ordinary commercial building delays.
- The Rule: The land remains legally “vacant” until the occupancy certificate is issued and the house is ready.
- Exceptional Circumstances: Exceptions only apply if a natural disaster (like a cyclone or flood) destroys an existing rental.
Q3: What exactly counts as a “substantial and permanent structure” to stop the land being vacant?
- Residential House: A completed dwelling that is legally habitable and ready for a tenant to occupy.
- What DOES NOT count: A concrete slab, a half-framed house, a backyard shed, or a caravan.
- The Threshold: The structure must have independent utility and be fixed permanently to the land.
Q4: If I use a single combined split-loan for land and build, can I still claim the construction interest?
- Yes, but it is an accounting nightmare.
- The Risk: A combined account creates a “contaminated loan” where payments split across different balances.
- The Solution: You must manually trace every single dollar drawn down to prove exactly what portion of interest belongs to the build.
Q5: Can I claim depreciation (Capital Works) while the property is being built?
- No. Division 43 capital works deductions cannot begin until construction is fully completed.
- The Trigger: The property must be completed and either rented out or actively advertised for rent.
- Pro Tip: Order a Quantity Surveyor Depreciation Schedule immediately at handover so you do not miss a single day of claims.
