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 start to use the property for private purposes, you cannot claim the interest expenses you incur after you start using the property for private purposes.
While the property is rented, or available for rent, you may also claim interest charged on loans taken out:
- to purchase depreciating assets
- for repairs
- for renovations.
Similarly, 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 decide to use the property for private purposes and you no longer use it to produce rent or other income, you cannot claim the interest after your intention changes.
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, for example, a private car. In cases of this type, the interest on the loan must be apportioned into deductible and non-deductible parts according to the amounts borrowed for the rental property and for private purposes. 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 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.
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 the case whether or not the loan for the new home is secured against the former home.
More complicated investment loan interest payment arrangements also exist, such as 'linked' or 'split' loans which involve two or more loans or sub-accounts in which one is used for private purposes and the other for business purposes. Repayments are allocated to the private account and the unpaid interest on the business account is capitalised. This is designed to allow you to pay off your home loan faster while deferring payments on your rental property loan and maximises your potential interest deduction by creating interest on interest.
This can create a tax benefit because the deduction for interest actually incurred on the investment account is greater than the amount of interest that might reasonably be expected to have been allowable but for using the loan arrangement outlined above. In this case we may disallow some or all of your interest deductions. You should seek advice from your recognised tax adviser or contact us to discuss your situation. For more information see Taxation Determination TD 2012/1.
If you prepay interest it may not be deductible all at once; see Prepaid expenses.
If you are an Australian resident and you or any associate entities have certain international dealings, overseas interests or if you are a foreign resident, thin capitalisation rules may affect you if your debt deductions, such as interest, combined with those of your associate entities for 2017–18 are more than $2,000,000.
Companies, partnerships and trusts that have international dealings will need to complete the International Dealings Schedule (IDS). See the International dealings schedule.
For more information about the deductibility of interest, see:
- Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities
- 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 98/22 Income tax: the taxation consequences for taxpayers entering into certain linked or split loan facilities
- Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts, FC of T v. Smith
- 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 Taxation Ruling TR 98/22 apply to line of credit facilities?
- Taxation Determination TD 2012/1 Income tax: can Part IVA of the Income Tax Assessment Act 1936 apply to deny a deduction for some, or all, of the interest expense incurred in respect of an 'investment loan interest payment arrangement' of the type described in this Determination?
- Expenses you can claim
If you need help to calculate your interest deduction, seek advice from your recognised tax adviser or contact us to discuss your situation.