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Edited version of private ruling
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Ruling
Subject: Interest expense
Question
If you take out a mortgage on your residential home which is presently unencumbered, and use the funds for private purposes, can you claim a deduction for the interest on the mortgage if you later rent the property out?
Answer
No.
This ruling applies for the following period
Year ended 30 June 2011
The scheme commenced on
1 July 2010
Relevant facts
You will be required to move to another location for family reasons.
Your residential home is unencumbered.
You wish to take out a mortgage on the house to enable you to use the funds to purchase a home at the location where you will be moving.
You intend renting your home when you move out.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Interest expenses are deductible under section 8-1 of the Income Tax Assessment Act 1997 to the extent that they are incurred in gaining or producing assessable income except to the extent that the expense is of a capital, private or domestic nature.
Taxation Ruling TR 95/25 deals with the general principles governing deductibility of interest following the decision of the Full Federal Court in FC of T v. Roberts; FC of T v. Smith 92 ATC 4380; (1992) 23 ATR 494.
TR 95/25 provides that the deductibility of interest is determined by the use to which the borrowed money is put. The use test is the basic test for the deductibility of interest and looks at the application of the borrowed funds as the main criteria (Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153).
The security used for the loan does not affect the deductibility of the interest expense incurred (Taxation Determination TD 93/13).
We accept that you are moving for family reasons and that your residential home will become income producing after you move. However, the use to which the funds will be put in your case is to purchase a home at your new location. Therefore, you are not entitled to a deduction for the cost of interest as it is considered to be private in nature.