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Edited version of private ruling
Authorisation Number: 1011635529564
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Ruling
Subject: rental deductions
Are you entitled to a partial deduction for the interest on the loan repayments and a partial deduction for the lease payments?
Yes.
This ruling applies for the following period
30 June 2009 to 1 July 2010
The scheme commenced on
1 July 2009
Relevant facts
You are making loan repayments to a government authority for 25% ownership of your principal place of residence. You also pay the authority a lease amount for the remaining 75% of the property. Both of these payments attract a reduced rate under the authority's rental purchase scheme.
You currently rent out one room at arms length. This tenant has an en-suited room and access to the dining room, kitchen and lounge room. The tenant also pays 50% of the electricity, pays 50% of the telephone line rental and has a separate telephone line.
The authority agrees that it is not required to receive part of the rental income that you generate. The authority requires that you remain living in the property to continue to receive the discounted rental amount. The authority pays or will reimburse the insurance on the property, otherwise all other costs are your responsibility.
Reasons for decision
An expense is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income.
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 criterion. The interest incurred will be deductible to the extent that the property is used to produce assessable income.
Generally, expenses relating to your principal place of residence are private in nature and not deductible.
However, when an area of the home is used for income producing purposes, the occupancy expenses relating to this area will be deductible. Occupancy expenses include expenses such as rent, mortgage interest, municipal and water rates and house insurance premiums.
As a general approach, apportionment may be made on a floor area basis, that is, by reference to the floor area of the residence to which the tenant lodger has sole occupancy together with a reasonable figure for access to the general living areas including the garage and outdoor areas. The floor area used to produce income is divided by the total area of the building to arrive at the percentage of the costs that can be claimed as a deduction.
Paragraph 10 of IT 2167 states that:
If, for example, the tenant/lodger had sole occupation of one room in the residence and shared the general living areas equally with the owner/occupier, it would be appropriate to add one half of the floor area of the general living areas to the floor area of the room of sole occupancy in order to make the necessary apportionment.
In your circumstances when you rented out, at arms-length, a part of your residence, the use to which the borrowed funds will be put, and the purpose of the lease, has changed. If, for example, one third of the property is rented out the interest deduction allowable is one third of the total interest charge. Also one third of the lease cost is deductible. When further areas of the property are rented out a similar calculation would be appropriate.