Edited version of private ruling

Authorisation Number: 1011695670266

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Ruling

Subject: Rental Property Deductions

Question and Answer

Will the interest component of the residual debt continue to be deductible for income tax purposes following the sale of our property?

Yes

This ruling applies for the following period:

Year ending 30 June 2011

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You and your spouse purchased a residential investment unit in 200X. The unit has been available for rent from purchase.

The unit was purchased in the name of you and your spouse.

The unit was purchased by way of an investment loan, 100% borrowing.

The loan amount also included the stamp duty applicable to the purchase.

Principal and interest payments commenced on this loan in the recent year with the loan converting to a variable interest rate at that time.

A separate line of credit was established in 200Y to pay for a refurbishment of the unit.

A minimum of interest only payments have been made to this line of credit since being established.

The line of credit has only been used on occasion to meet other expenses incurred only in relation to the unit.

The unit was sold with settlement occurring in the recent year.

A residual debt remains on the investment loan.

The line of credit has been repaid and cancelled.

Monthly repayments will be made to clear the residual debt.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Interest deductions

Section 8-1 of the 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 (TR 2004/4) provides the Commissioners view of the law in relation to the deductibility of interest which accrues after the income producing activity for which a loan was raised has ceased. This ruling also considers the nexus between the outgoing and the income earning activities.

According to paragraph 10 of TR 2004/4 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 have ceased, it is apparent that the interest is not incurred in gaining or producing assessable income.

However, paragraph 10 of TR 2004/4 goes onto state that, 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.

However, as outlined in paragraph 13 of TR 2004/4, if the taxpayer keeps the loan on foot for reasons not associated with the former income earning activities; or extends the loan for reasons unrelated to earning assessable income as the original loan was, the nexus between the outgoings of interest and the relevant income earning activities will be broken.

According to paragraph 14 of TR 2004/4 a legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities.

Deductibility of the interest

You and your spouse purchased a residential investment unit in 200X. This property has been used for rental purposes since purchase.

You purchased the property by way of an investment loan. Originally the loan was on a fixed rate interest only basis. The principal and interest payments commenced on this loan in the recent year with the loan converting to a variable interest rate at that time.

The unit was sold with settlement occurring in late the recent year and a residual debt remains on the investment loan. You have planned to repay the loan with monthly repayments.

From the information you have provided it is evident that you have not kept the loan for any other reason than it was originally intended.

Consequently you are entitled to a deduction for the interest expenses under section 8-1 of the ITAA 1997.

Additional Information

You have also noted in your ruling request as to whether there is a minimum amount of principal reduction required to clear the residual debt, and if there is a reasonable period to repay the residual debt.

Under tax law and the Commissioners interpretations there is no set time period as to when you should pay the debt off, or any set minimum amount that needs to be paid.

However paragraph 48 of TR 2004/4 states:

By contrast, where the taxpayer does have the legal power to repay the loan and hence avoid incurring interest liabilities, the reasoning of Dowsett J in Jones in the first instance suggests the nexus will continue until a time at which it can be inferred that:

· the taxpayer has kept the loan on foot for reasons unassociated with the former business; or

· the taxpayer has made 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.

As a result you will be able to continue deducting the interest amounts until it can be inferred that you have kept the loan outstanding for reasons unassociated to former income earning. Alternatively you will also not be able to deduct the interest if you have extended the loan in such away that it is no longer related to the earning of the original income and the original debt incurred.