Building a discounted new home rentback to builder for $1 a week - tax implications?

What are the taxation implications of building a new home at a large discount, in return for allowing the builder to rent it back for use as a display home for 18 months at $1 per week?

I've been told I can't claim the normal full tax deductions as it is an intentionally loss-making venture even though I thought I could argue that I was planning to make a large capital gain and hence (maybe) pay large CGT.

There is a couple of possiblilties:-

The ATO Rental Properites 2011 guide states that rent can be "associated payments in the form of goods and services and that you will need to work out the monetary value of these". So my discount is sort of like a goods and service ie. I'm getting the builders time for free or heavily discounted. If I could determine what the monetary value of this was (eg. ask him to provide me with the full cost and the discounted cost?), I could divide it by 18 months to determine the rent I would need to declare. Therefore I'd be able to claim all the normal deductions.
Furthermore, someone has suggested that this discount could be added onto my cost base for capital gains tax purposes but I find this hard to believe.

Another possibility is to determine what the market value of the rent (ask a real estate agent?) would be, and declare this as the "monetary value" of the discount I received.

I can't see any guidance to this situation in "Taxation Ruling IT 2167 - Income Tax: rental properties - non-economic rental...". It talks about renting a property at a discount to relatives, holiday homes, not at arms length transations etc. But I can't see anything relevant to my situation.

Has anyone had any experience in this area of renting back a property at a huge discount, in exchange for obtaining a lower purchase cost, and if so, what were the income tax implcations?
The test is whether there is an 'income producing purpose' to the transaction. Obviously $1 a year is not an arms-length transaction - the $1 is just to make the contract have consideration and therefore be legally binding.

While the $1 is 'income' it's not really valid from the ATO's perspective. You shouldn't mix up the discount you received on the building itself with the rental income (or market value of that rental). One is the cost base of the asset, the other is the income flowing from the asset. They are two separate things. You better get an accountant to advise you on it.
Thanks very much to jacee, Aaron C, Rolf and coastymike.

I have had an advice from my accountant and he explained that the $1 a week rent would not allow me to claim deductions and he explained the difference between income and capital gains. He further offered the first and, less convincingly, the second of the two possibilities I outlined earlier (apportioning the discount ‘benefit’ over 18 months, or declaring the normal market rent I should have received as the ‘benefit’) . I wanted a second opinion as I wasn’t 100% comfortable with these suggestions.

Further research and discussions with my accountant suggest that I will have to declare the "monetary value" of the discount I received apportioned over 18 months as rental income. So I will need to obtain in writing from the builder my cost price and the undiscounted cost price so I can include this as income. It’s at this point that I will have to decide whether to pay the extra so that I can move in straight away (if the extra is low enough to be affordable), or if the extra is unaffordable, crunch the taxation numbers (deemed income versus deductions) to see whether that will increase or reduce my costs over the 18 month period.

Yes, I might be better off doing it the “normal way” as jaycee mentions, paying extra for the build and getting a market type rate of rent in return, but I never do property or banking in a normal way! If I can get the property for a good price I’ll move in straight away (this whole process started from the premise of getting more home for less in return for delaying immediate benefit by postponing living in it for 18 months, but it has started to look a bit complex from a taxation point of view).

As for finance, I’m hoping that the deal will be sufficiently under LVR of 80% so it has a bit of a buffer if the bank’s valuation is lower.

I might keep it extremely simple and move in immediately if the price is right.
A better solution would be for you to work out the market rate of the rent over this period, get the builder to bill you for it and then treat the rent you would have received as loan repayments. You have a higher cost base for the property and get to claim deductions in full. The builder will probably have tax problems themselves on this issue. The tax office certainly won't view this transaction positively.

I would have a chat to Coastymike's contact or lodge a private ruling. I can see the tax office limiting your deductions to the $1 as non-economic rent under Part IVA.