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Edited version of your written advice
Authorisation Number: 1012673839059
Ruling
Subject: Interest expenses
Question
Are you entitled to a deduction for the interest you incur on both loans referable to the purchase of your rental property?
Answer:
Yes, to the extent it does not relate to deriving non-assessable, non-exempt income.
This ruling applies for the following period(s)
Year ended 30 June 2014
The scheme commences on
1 July 2013
Relevant facts and circumstances
This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.
You own your home.
You entered a contract to purchase a property under the National Rental Affordability Scheme (NRAS).
You obtained two new loans for the purchase of the NRAS property.
The NRAS property was rented or available for rent for the relevant period.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 8-1(2)
Income Tax Assessment Act 1997 Section 8-1(2)(c)
Reasons for decision
Deductibility of interest
Section 8-1 of the Income Tax Assessment Act 1997 allows you a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income, to the extent that it is not of a private, capital or domestic nature.
Whether interest has been incurred in the course of gaining or producing assessable income generally depends on the purpose of the borrowing and the use to which the borrowed funds are put.
Where a borrowing is used to acquire an assessable income producing asset, or relates to expenses of an assessable income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income. The character of a new loan which refinances a previous loan follows from that previous loan: Taxation Ruling TR 95/25.
In your situation it is accepted that you have used the rental loans for an income producing purpose, being the acquisition of an income producing rental property. However, because the rental property is being used to participate in NRAS, the property earns both assessable rental income as well as certain tax free incentives which must be explored further.
Deductibility of NRAS expenses
While derivation of assessable income by way of rent is one objective achieved by participation in the NRAS, the receipt of government incentives, including state government payment is another. The state government payment is NANE income: Section 380-35 of the ITAA 1997.
Expenses are not deductible to the extent they are incurred in gaining NANE income (paragraph 8-1(2)(c) ITAA 1997). Accordingly rental expenses (including interest) incurred in respect of an NRAS rental property must be apportioned, limiting a claim for any deduction to the portion of costs relating to the derivation of assessable income.
Generally this apportionment of expenses would be made using the following formula to calculate the percentage of deductible expenses:
Otherwise deductible expenses x assessable rental income derived from the property Assessable rental income + NANE income associated with the property
In your situation it is accepted that you have used the rental loans for an income producing purpose, being the acquisition of an income producing rental property. However, because the rental property is being used to participate in NRAS, the property earns both assessable rental income as well as certain tax free incentives.
Because NRAS properties earn both assessable rental income and a non-assessable non-exempt state government incentive, the rental expenses, including the interest expenses, must be apportioned between both forms of income accordingly to the formula detailed above.
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