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Edited version of private ruling
Authorisation Number: 1011632181117
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Ruling
Subject: interest deductions
1. Are you entitled to claim a deduction for the interest incurred on the remaining balance of your investment loan?
Yes.
2. Are you entitled to claim a deduction for interest incurred on a loan used to purchase your main residence?
No.
This ruling applies for the following period
Year ended 30 June 2010
The scheme commenced on
1 July 2009
Relevant facts
Property A was your main residence.
You and your spouse later purchased an investment property (Property B) using a bank loan, secured by both Property A and Property B.
A few years later, you sold Property A and purchased a new main residence (Property C); both properties settled on the same day.
As Property A was part of the security for Property B, the bank required half of the loan remaining on Property B be paid out when Property A was sold.
A new loan was established for the same amount for the purchase of Property C.
You informed your mortgage broker that this arrangement would not be suitable.
You have provided a copy of an e-mail received from your mortgage broker, dated four weeks prior to settlement, which states that there was no other way to proceed other than to reduce your investment property loan in the way described.
You believe the bank should have just substituted Property A with Property C as security for Property B and the proceeds of the sale of Property A should have been used to purchase Property C.
Upon settlement, the bank used a portion of the sale proceeds of Property A to reduce your investment loan on Property B and provided you with a new separate loan to purchase Property C.
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.
Taxation Ruling TR 95/25 considers the deductibility of interest. 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 criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income.
In your case, you took out an investment loan to purchase a rental property, Property B. You used two properties, Property A (your main residence) and Property B, as security for the investment loan. When you later entered contracts to sell Property A and purchase Property C, the bank informed you, four weeks prior to settlement, that you would need to repay a portion of your investment loan from the proceeds of the sale of Property A and a new loan would be established for the purchase of Property C. You were aware at this time that there was no other option but to reduce your investment loan.
At settlement, of both the sale and purchase, the bank applied a portion of the sale proceeds from Property A to the investment loan and provided a new loan for the purchase of Property C.
As the debt owing on your investment property was reduced, you are only entitled to claim a deduction for interest incurred on the remaining balance. Even though the new loan was provided for a similar amount, it was used to purchase your new private residence and not for an income producing purpose, therefore, the interest incurred on this loan will not be deductible.
It is acknowledged that you believe the bank should have just substituted Property A with Property C as security for Property B and the proceeds of the sale of Property A should have been used to purchase Property C. However, the Commissioner does not have any discretion to allow you to claim a deduction for interest incurred on a loan used to purchase your private residence.