If you take out a loan to purchase a rental property, you can claim the interest charged 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.
If you take out a loan to purchase land on which to build a rental property or to finance renovations to a property you intend to rent out, the interest on the loan will be deductible from the time you took the loan out. However, if your intention changes – for example, you instead use the property for private purposes and the property is not used to produce rent or other income, you cannot claim the interest after your intention changes.
Additionally, while the property is rented, or available for rent, you may also claim interest charged on loans taken out:
- to purchase depreciating assets
- for renovations
- for repairs.
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 parts 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 that applies to the rental property portion of the loan; that is, you must separate the interest that relates to the rental property from any interest that relates to the private use of the funds.
If you have difficulty calculating your deduction for interest, contact your professional adviser or the ATO.
If a loan is taken out to purchase a rental property and you start to use the property for private purposes, you cannot claim any interest expenses you incur after you start using the property for private purposes.
Some rental property owners borrow money to buy a new home and then rent out their previous home. If there is an outstanding loan on the old home and the property is used to produce income, the interest outstanding on the loan, or part of the interest, will be deductible. However, an interest deduction cannot be claimed on the loan used to buy the new home because it is not used to produce income. This is so whether or not the loan for the new home is secured against the former home.
Example: Apportionment of interest
The Hitchmans decide to use their bank's 'Mortgage breaker' account to take out a loan of $209,000 from which $170,000 is to be used to buy 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 annum, and assuming that the property is rented from 1 July.
Interest for year 1 = $209,000 × 6.75% = $14,108
Apportionment of interest payment related to rental property:
Total interest × (property loan total ÷ borrowings interest = deductible expense
$14,108 × ($107,000 ÷ $209,000) = $11,475
End of exampleIf you prepay interest it may not be deductible all at once. Read the section Prepaid expenses.
Note: Thin capitalisation
New rules – known as the thin capitalisation rules – apply from 1 July 2001. If you are an Australian resident and you (or any associate entities) have certain overseas interests, or you are a foreign resident, these rules may apply if your debt deductions, such as interest (combined with those of your associate entities), for 2002-03 are more than $250,000. See the publication Guide to thin capitalisation, complete the Thin capitalisation schedule attached to the guide and, if required under the thin capitalisation rules, only claim a reduced amount. These publications are also available on the ATO internet site at www.ato.gov.au
For more information about the deductibility of interest, see the following taxation rulings and determination:
- Taxation Ruling 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
- Taxation Ruling TR 98/22 Income tax: the taxation consequences for taxpayers entering into certain linked or split loan facilities
- Taxation Ruling TR 93/7 Income tax: whether penalty interest payments are deductible
- Taxation Determination TD 1999/42 Income tax: do the principles set out in TR 98/22 apply to line of credit facilities?
- Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities
- Taxation Ruling TR 2000/17 (with the Addendum TR 2000/17A) Income tax: deductions for interest following the Steele and Brown decisions.
If you need help to calculate your interest deduction, contact your professional adviser or the ATO.