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  • Interest



    This information may not apply to the current year. Check the content carefully to ensure it is applicable to your circumstances.

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    If you take out a loan to purchase a rental property, you will generally be entitled to claim the interest on that loan, or a portion of the interest, as a deduction. However, the property must be rented, or available for rental, in the income year for which you claim a deduction.

    You may also claim interest on loans taken out to purchase items of plant, for renovations, or for repairs to the property occasioned by your use of the property to produce assessable rental income.

    Banks and other lending institutions offer a range of financial products which can be used to acquire a rental property. Many of these products permit flexible repayment and redraw facilities. As a consequence, a loan might be obtained to purchase both a rental property and a private car. In cases of this type, the interest on the loan must be divided into deductible and non-deductible components according to the amounts borrowed for the rental property and for private purposes. A simple example of the necessary calculation is shown in the example Apportionment of interest.

    If you have a loan account that has a fluctuating balance, due to a variety of deposits and withdrawals and it is used for both private purposes and for rental property purposes, you must keep accurate records to enable you to calculate the interest applicable to the rental property portion of the loan; that is, you must separate that interest which relates to the rental property from any interest applicable to private use of the funds. An example of this type of arrangement is a line of credit where your salary is paid into the mortgage account.

    If you have difficulty calculating your entitlement to a deduction for interest, contact your professional adviser or the ATO.

    If you restructure your rental property borrowing arrangements, and you incur a charge for a penalty interest payment-that is, interest that would otherwise have accrued on those borrowings-you may be able to claim a deduction for the amount of that charge. Such a situation could arise where you renegotiate a loan agreement that has a fixed interest rate to provide for a variable interest rate, and you are required to pay an amount which represents interest that the lender would have otherwise charged under the terms of the original borrowing arrangement.

    If a loan is taken out to purchase an income-producing property and the property ceases to be used for income-producing purposes, you are not entitled to claim for any ongoing interest expenses you incur after that time.

    Some rental property owners borrow money to buy a new residence and then rent out their previous residence. If there is an outstanding loan on the old residence and that property is used for income-producing purposes, the interest outstanding on the loan, or part of the interest, will generally be deductible. However, an interest deduction cannot be claimed on the loan used to buy the new residence because it is not income producing. This is so whether or not the loan for the new residence is secured against the former residence.

    Example: Apportionment of interest

    The Johnsons decide to use their bank's 'Mortgage breaker' account to take out a loan of $209,000 from which $170,000 is to be paid for a rental property and $39,000 is to be used to purchase a private car. The bank officer advises them that they will need to work out each year how much of their interest payments is tax deductible. The officer gives them the following whole year example based on a loan interest rate of 6.75 per cent per annum, and assuming that the property is rented from 1 July.

    Interest for 1 year = $209,000 × 6.75% = $14,108

    Apportionment of interest payment related to rental property:

    Total interest expense × (rental property loan ÷ total borrowings) = deductible interest

    $14,108 × ($170,000 ÷ $209,000) = $11,475

    End of example

    For more information about the deductibility of interest, see the following taxation rulings and determination:

    • TR 95/25 - Income tax: deductions for interest under subsection 51(1) of the Income Tax Assessment Act 1936 following FC of T v. Roberts, FC of T v. Smith
    • TR 98/22 - Income tax: the taxation consequences for taxpayers entering into certain linked or split loan facilities
    • TR 93/7 - Income tax: whether penalty interest payments are deductible
    • TD 1999/42 - Income tax: do the principles set out in TR 98/22 apply to line of credit facilities?
    • TR 2000/2- Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities

    If you need help to calculate your interest deduction, contact your professional adviser or the ATO.

    Last modified: 28 Jul 2003QC 16187