Edited version of private ruling

Authorisation Number: 1011648871486

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Ruling

Subject: interest deductions

1. Will you be entitled to claim a deduction for 100% of the interest charged on your investment property loan where you have redrawn funds for a private purpose?

No.

2. Will you be entitled to claim a deduction for the portion of the interest attributable to an income producing purpose?

Yes.

This ruling applies for the following period

Year ending 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You and your spouse own an investment property.

You took out a mortgage over your private residence to fund the purchase of the investment property.

You are now in the process of selling your private residence.

When your private residence is sold, part of the sale proceeds will be used to pay out the mortgage.

You may need to redraw these funds at a later date to fund the purchase of a new private residence.

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 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 used a mortgage over your private residence to fund the purchase of an investment property. As the use of these funds was for an income producing purpose, the interest incurred on the loan is an allowable deduction.

Taxation Ruling TR 2000/2 states that the deductibility of interest on a further borrowing of money under a redraw facility depends upon the use to which the redrawn funds are put. Where the original borrowing is for income producing purposes and the taxpayer uses the redrawn funds wholly or partly for non-income producing purposes, that part of the accrued interest attributable to the redrawn funds used for non-income producing purposes is not deductible.

In your case, you will be required to partially payout the loan used to purchase your investment property when you sell your private residence and you may need to redraw these funds at a later date to fund the purchase of a new main residence. The withdrawal of additional funds from this loan will be regarded as a new borrowing or redraw; just as any new borrowing for a similar amount is a separate borrowing. The deductibility of the interest on that separate borrowing depends on the use of the funds and whether the interest is incurred in gaining or producing assessable income.

In your situation, the 'new borrowing' will be used to fund the purchase of a new private residence and not for an income producing purpose.

As the redrawn funds will be used for a non-income producing purpose, a deduction for the interest incurred on the redrawn portion of the loan is not an allowable deduction under section 8-1 of the ITAA 1997.