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Ruling

Subject: Interest expenses

Question 1

Are you entitled to a deduction for interest on an existing loan when it was originally used to acquire your principal place of residence but will be converted into an investment property after you acquire your spouse's share of the property?

Answer

Yes.

Question 2

Are you entitled to a deduction for interest payments on a loan, where the proceeds of the loan are used to purchase your spouse's share of the property, at market value, for the purpose of deriving rental income?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 2012

The scheme commences on

1 July 2011

Relevant facts and circumstances

You and your spouse purchased your primary place of residence and obtained finance.

You have both lived in the home since with the exception of three years when you moved away due to employment and rented the property. At that stage you refinanced your loan and incorporated a car loan. For taxation purposes only the percentage of the house loan was used for calculating of interest.

In 2008 you purchased land to build and arranged finance to repay your car loan reducing your home loan with interest only payments.

You returned to your home and later sold your land and purchased a new home jointly with your spouse which will be your primary place of residence.

You have retained your other property as an investment and have rented the property at market rates.

You want to buy your spouse's share of the investment property based on the current market value and have yourself as the sole titleholder.

You are arranging finance for this property in your name and have sole ownership of the property with a new loan based on your bank's valuation.

Your spouse will receive her half share of the property of which will repay her half of the original loan, capital gains and her share of the mortgage of the new primary place of residence.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature.

Taxation Ruling TR 95/25 provides that the deductibility of interest is determined by the use for which the borrowed money is intended. The use test looks to the application of the borrowed funds as the main criteria (Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153). Where borrowed funds are used for investment purposes such as the acquisition of a rental property, the interest will be deductible to the extent that the property is used to produce assessable income.

In your case, you jointly own your primary place of residence which you have converted into an investment property and you intend to acquire your spouse's share of the property at market value. You and your spouse have a loan on the property. You intend to buy your spouse's share by taking out another loan. You want to claim interest deductions on the loan you will then have on the property, in which you will have a 100% ownership interest.

The interest on this loan is fully deductible whilst you are earning assessable income from the property. You will have a 100% ownership interest and the interest on the new loan will be fully deductible as you are using the property for income-producing purposes.