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Edited version of private ruling
Authorisation Number: 1011607436609
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Ruling
Subject: Rental property loan interest
Question
Can you claim a deduction for interest on a loan when the property ceases to be a rental property and becomes your principal residence?
Answer: No.
This ruling applies for the following period
Year ended 30 June 2011
The scheme commenced on
1 July 2010
Relevant facts
You purchased a rental property. You have a loan for the rental property, and currently have the property rented out.
You are considering moving into the rental property and renting your current home out.
Reasons for decision
Section 8-1 of the Income Tax Assessment Act 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.
Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest will be deductible to the extent that the property is used to produce assessable income.
Taxation Ruling TR 95/25 states that interest on borrowings will not continue to be deductible if the borrowed funds cease to be employed for an income producing activity. It is not considered that the nature or use of the borrowed funds can be notionally altered or amended at a future time.
In your situation you have borrowed money to purchase a property which is currently being used as a rental property. As the property is producing assessable income the interest would be deductible under the use test. However, if the property was to cease being a rental property and you moved into the property and used it as your principal place of residence the use to which the borrowed funds would be put would become private in nature and the interest would cease to be deductible.
If you were to rent out your current private residence this would not alter the fact that the use of the funds borrowed for the current rental property would be private and non-deductible.
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