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Subject: investment loan interest

Question

Are you entitled to a deduction for your share of interest on the remainder of an investment loan after the property was sold?

Answer

Yes.

This ruling applies for the following periods

Year ending 30 June 2009

Year ending 30 June 2010

Year ending 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2008

Relevant facts and circumstances

You borrowed to purchase a rental property with your spouse. When you sold the property you applied all of the sale proceeds to the property loan. There were insufficient funds from the sale to pay out the loan, and you are still paying interest on the balance of the loan.

You and your spouse were equal joint owners of the property, as shown on the property title deed.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

The nexus between the expense and the income earning activity has not been broken; therefore a deduction is allowable for the interest expense, apportioned according to legal title of the investment property involved.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 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.

Interest expenses are generally deductible under section 8-1 of the ITAA 1997 to the extent that it is incurred in relation to funds used for an income producing purpose.

The Commissioner's view on whether interest deductions are allowable after the cessation of the relevant income producing activity is outlined in Taxation Ruling TR 2004/4.

TR 2004/4 considers the implications of the Full Federal Court decisions in Federal Commissioner of Taxation v. Brown 99 ATC 4600; (1999) 43 ATR 1 (Browns case) and Federal Commissioner of Taxation v. Jones 2002 ATC 4135; (2002) 49 ATR 188 (Jones case).

In Brown's case, the taxpayer partners borrowed to acquire a delicatessen. After a number of years of trading, the business was sold at a loss. The proceeds of the disposal were made over to the bank but were insufficient to satisfy the liability fully. There was no entitlement under the relevant loan agreement to repay the loan prior to its term without prior agreement of the bank.

In Jones case, the taxpayer, together with her husband, borrowed money to fund a trucking and equipment hire business. After her husband's death, Mrs Jones sold the assets of the business. The proceeds (plus other amounts on hand) were insufficient to pay out the loan and she was unable to fully repay the loan.

The above cases accordingly demonstrate that the occasion of interest expenditure can be found in the relevant income earning activities even where those activities are now defunct and all the borrowings (or assets representing those funds) are lost.

Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities.

If the taxpayer:

In your case, the funds from the sale of the property were insufficient to pay out the loan in its entirety, therefore, the loan was kept on foot for reasons directly related to the income earning activities and the nexus between the interest expense and the relevant income earning activity has not been broken. As a result, the interest expense is an allowable deduction under section 8-1 of the ITAA 1997.

Taxation Ruling TR 93/32 discusses the division of net income or loss between co-owners of a rental property. The ruling explains that the loss or income from a rental property must be shared according to the legal interest of the owners, except in those very limited circumstances where there is sufficient evidence to establish that the equitable (or beneficial) interest is different from the legal title.

As you and your spouse were equal joint owners of the property, the interest deduction will be apportioned equally between you.

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