1052395856610 | Legal database

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Edited version of private advice

Authorisation Number: 1052395856610

Date of advice: 27 May 2025

Ruling

Subject: Rental property - deductions

Question 1

Are you entitled to claim a deduction for the interest expenses you are incurring from a loan you obtained to purchase your rental property after you sold the rental property at a loss?

Answer 1

Yes.

Given that the purpose of the loan remains strictly related to the purchase of your rental property, which was an income producing asset, you can claim a deduction for the ongoing interest expenses under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

Further information about the deductibility requirements for loaned funds can be found in the taxation rulings TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities and Taxation Ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities, accessible via the ATO's legal database on ato.gov.au.

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commenced on:

XX XX 20XX

Relevant facts and circumstances

On XX XX 20XX, you and your spouse bought an investment property for $XXX.

On XX XX 20XX, the property was first made available for renting.

The property was managed by a Real Estate Property Management.

Your relationship to the tenants was Landlord.

The property was leased at market rate this was determined by the Real Estate Property Management.

The property was vacant for several months in 20XX due to the Covid-19 pandemic.

The property has never been used by you personally.

You mortgaged the property to a single creditor being XXX bank.

Your loan varied during the years;

• XX 20XX to XX 20XX Fixed, Interest only for first two years from purchase.

• XX 20XX to XX 20XX Fixed, Principal & Interest.

• XX 20XX to XX 20XX Variable, Principal & Interest.

The loan for the property was under your name and your spouse's name.

The names against the loan have not changed since you purchased the property.

The loan has not been refinanced.

The loan was used to cover the purchased of the property and part of the stamp duty and fees.

The loan has only been used for the purchase of the property.

On XX XX 20XX, the property was sold at a loss for $XXX.

Due to the loss on sale, the loan was not paid in full, and the outstanding balance is $XXX

The loan was settled through XXX after sale of property.

There was no security on the loan.

The investment loan contract remains unchanged.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the ITAA 1997 general deductions states you can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(d) a provision of this Act prevents you from deducting it.

In determining whether a particular outgoing of interest incurred after the cessation of the relevant income earning activities is deductible, it is useful to contrast cases in which the continuing liability to interest is seen to be merely a burdensome legacy of the past (suggestive of a continuing nexus with prior assessable income) with cases in which that liability is seen to be associated with present or future advantages (suggestive of a broken nexus).

TR 2004/4 explains at paragraph 47, that Cases in which the taxpayer does not have the legal power to repay the loan early and hence is unable to avoid incurring ongoing interest liabilities belong to the first category (ie a burdensome legacy of the past). In these cases, a nexus will continue to exist between the interest outgoings and the relevant income earning activities at least until the end of the period during which the interest cannot be avoided. Brown is an example of such a case. In Brown, there was no entitlement under the relevant loan agreement to repay the loan prior to its term without prior agreement of the bank.

Paragraph 48 by contrast, where the taxpayer does have the legal power to repay the loan and hence avoid incurring ongoing interest liabilities, the reasoning of Dowsett J in Jones in the first instance suggests the nexus will continue until a time at which it can be inferred that:

• the taxpayer 'has kept the loan on foot for reasons unassociated with the former business'; or

• the taxpayer has made 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.

Paragraph 49 states in deciding in any particular case whether such inferences can be drawn, it is necessary to undertake a commonsense or practical weighing of all the factors of the case. As was recognised by the Court in Brown:

there may come a period of time between cessation of business and the payment of interest which is such that, in all the circumstances of the case, the payment is no longer sufficiently proximate to the activities of the business to be deductible under s 51(1) with the consequence that those activities no longer provide the occasion for the outgoing... Answers to such questions depend upon a 'commonsense' or 'practical' weighing of all the factors: see Fletcher at ATC 4958; CLR 18.

Paragraph 50 says in weighing the factors of a case, regard should be had to the following general observations:

• The less the financial resources of the taxpayer, the more likely it is that an inference could be drawn that the existence of a continuing obligation to pay interest is a burdensome legacy of the past rather than a result of the taxpayer choosing to keep the loan on foot for reasons unassociated with the former income earning activities. Jones is an example of a case in which the limited financial capacity of the taxpayer was given considerable weight by the Court in determining whether interest incurred by the taxpayer after the cessation of the relevant income earning activities continued to be deductible;

• The more liquid the resources of the taxpayer, the more likely the inference could be drawn that the loan is being kept on foot for reasons unassociated with the former income earning activities. For example, where there are sufficient funds held in cash or on deposit in a bank account that could relatively easily be applied in repayment of the principal, the refusal to make such repayment would suggest that the loan is being kept on foot for other reasons. However, the inference is unlikely to be drawn if it would be unreasonable in the circumstances to expect the taxpayer to apply their liquid resources against the loan;

• The realisation or exchange of assets without a diversion of these resources in repayment of the principal will tend to indicate a breaking of any nexus that might previously have been maintained even after the cessation of the income earning activities. For example, the decision to realise shares and use the proceeds to purchase a leisure XX rather than make a repayment would be highly suggestive of a break of any previously existing nexus. On the other hand, though, the sale of a taxpayer's residence and the use of the proceeds to purchase another closer to a new place of employment would typically not have that effect;

• The greater the time since the cessation of the income earning activities, the more likely it is that an inference could be drawn that the continuing obligation to pay interest is a result of the taxpayer choosing to keep the loan on foot for reasons unassociated with the former income earning activities; and

• Refinancing of a loan does not of itself break the nexus between outgoings of interest under the loan and the prior income earning activities. However, the decision to refinance may, in all the circumstances, lead to the inference being drawn that the taxpayer has made a conscious decision to extend the loan, and has done this in order to derive an ongoing commercial advantage.

In your circumstances the interest will be deductible under section 8-1 of the ITAA 1997. However, where it is initially considered that the interest is deductible, there may come a time when the nexus is no longer considered to exist. As an example, if the loan is still in existence a decade after the rental property was sold, it would be difficult to accept that the loan could not have been paid off sooner and was not being kept 'on foot' for the tax deduction benefits.

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