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Ruling
Subject: Rental property expenses - interest
Question 1:
Are you entitled to claim a deduction for interest incurred on a loan used to purchase an income producing property after the cessation of the relative income earning activity?
Answer:
Yes
This ruling applies for the following period
Year ending 30 June 2012
The scheme commences on
1 July 2011
Relevant facts and circumstances
You purchased a rental property in the 2007-08 financial year. The property has been used to produce assessable income since it was purchased.
You borrowed funds to purchase the property.
The property was sold during the 2010-11 financial year. The sale proceeds were applied to reduce the loans but were insufficient to fully repay the loans.
The remaining loan amounts are still incurring interest and have since been amalgamated with other private loans for cash flow purposes.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
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, or relate to the earning of exempt income.
Taxation Ruling TR 2004/4 deals with the deductibility of interest when it is incurred prior to or after the cessation of the relevant income earning activity.
Paragraphs 10 to 14 of TR 2004/4 state the following in respect of interest incurred after the cessation of the relevant income earning activity:
Where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period.
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.
An outgoing of interest in such circumstances will not fail to be deductible merely because:
· the loan is not for a fixed term;
· the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; or
· the original loan is refinanced, whether once or more than once.
However, if the taxpayer:
· keeps the loan on foot for reasons unassociated with the former income earning activities; or
· makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred,
· the nexus between the outgoings of interest and the relevant income earning activities will be broken.
A legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities.
In your case, the original finance was obtained in order to acquire an income producing rental property. Hence the interest on the finance is held to be incurred or gaining or producing assessable income, and is hence deductible under section 8-1 of the ITAA 1997.
As stated in TR 2004/4, if interest incurred after an income producing activity has ceased can be traced back to the original income earning activity, it will continue to be deductible. This will not change even if the loan is refinanced. As a proportion of the interest on your current loan is being charged on monies used to refinance the sources of finance used to purchase your rental property, this interest will continue to be deductible as it is being incurred in relation to the original income earning activity.
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