Edited version of private ruling

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Ruling

Subject: Investment property deductions

Question

Can a deduction be claimed for interest incurred in respect of an investment property after the property has been sold?

Answer

Yes

Relevant facts and circumstances

You purchased an investment property and borrowed 100% of the cost.

Eighteen months later you sold the property at a loss, which left you with an outstanding loan balance at the settlement date.

You have had various interest only loans over the premises and have since converted the current loan to repayments of principal and interest.

Your intention was to hold the property for five to ten years until the value increased to the point where you could sell, pay back the loan and have a profit left over. You were relying on being able to rent the property in order to assist with the loan repayments.

The property was available for rent from the date of construction through an estate agent but you did not attract a tenant until six months later. The tenant departed after nine months and you realised that because of an over supply of housing in the area you could no longer keep the property.

The loan has been retained because you do not have the means available to pay the balance out.

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, or relate to the earning of exempt income.

Taxation Ruling TR 2004/4 considers the deductibility of interest incurred after the cessation of the relevant income earning activity following the decisions in Federal Commissioner of Taxation v. Brown (1999) FCA 721; (1999) 43 ATR 1; 99 ATC 4600 and Federal Commissioner of Taxation v. Jones [2002] FCA 204; 2002 ATC 4135; (2002) 49 ATR 188.

The ruling states at paragraph 10 that where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period.

At paragraph 13 the ruling notes that, if the taxpayer keeps the loan on foot for reasons not associated with the former income earning activities or makes 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, the nexus between the outgoings of interest and the relevant income earning activities will be broken.

In your case, the loan was entered into to acquire an income-producing asset. The funds were used to purchase an investment property which produced rental income. You did not use the original borrowed funds for any other purpose. Furthermore, an obligation was undertaken to pay interest until the principal was repaid. The issue, therefore, is whether selling the investment property severs the connection between the incurring of the interest expenses and your previous income producing activity.

Following the sale of the property you applied the proceeds of the sale towards the loan but were unable to completely pay off the loan. The failure to repay the entire loan was therefore attributable to the fact that you were not in a financial position to do so, as opposed to maintaining the loan for other reasons.

In your circumstances, the selling of the rental property did not sever the nexus with your previous income earning activities and the incurring of the interest is sufficiently proximate to your former income earning activities for the interest to be deductible.

Accordingly, the interest you incur on the loan balance remaining unpaid at the settlement date for the sale of the property is deductible under section 8-1 of the ITAA 1997.