Edited version of your private ruling

Authorisation Number: 1012148924374

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Ruling

Subject: property expenses

Question 1

Can you claim a deduction for all of the interest paid on the portion of your property which is used for rental purposes?

Answer

Yes.

Question 2

Will you be able to disregard the capital gain or loss that is applicable to the portion of the unit for the period that it is your principal place of residence?

Answer

Yes.

Question 3

Will the rate of payment of the loan against your principal place of residence with your own income have any affect on deductibility of the interest on the investment loan?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are going to purchase a property which is registered with two units on one land title.

The two units are almost identical in floor plan, fittings and condition.

You will live in one of the units and treat it as your principal place of residence, and rent out the other as an investment property.

You will establish two separate principal and interest loans for identical amounts which in total will be used to buy the property.

You currently have your present home for sale, and the proceeds from the sale will be used to pay down a portion of the loan which relates to the new principal residence.

You will pay the principal place of residence loan with your own income.

The rental income will be used to repay the loan on the rental property, which you will supplement from your other income, as the rent alone will not cover the loan repayments and outgoings.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

A deduction is allowed under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for an expense incurred in gaining or producing assessable income except to the extent that it is of a capital, private or domestic nature. Whether interest satisfies the requirements of this provision depends on all the facts relating to that expense. The interest expense must have a sufficient connection with the activities that produce assessable income.

A tracing of the borrowed money which establishes that it has been applied to an income producing use may demonstrate that connection. The test is one of characterisation. The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the funds are put.

Generally, if there is a dual purpose asset, the funds borrowed are considered to have the same dual purpose. In such a case, the principles of apportionment will apply to allow a deduction for the interest on the borrowing to the extent to which the asset is used for an income producing purpose.  However, these general rules were considered by the Federal Court of Australia in FC of T v. Carberry 20 ATR 151; 88 ATC 5005 (Carberry), which modified the rules in special circumstances.

 In Carberry, a married couple were allowed a deduction for the full amount of interest on a loan used to purchase a property consisting of a residence and a kindergarten business, where it was shown that the whole of the loan related to the purchase of the business and the residence was purchased with the proceeds from sale of their previous home.

 Taxation Ruling IT 2661 outlines the special circumstances in which a taxpayer who borrows money to purchase an asset, part of which is to be used for an income producing purpose and part for a non-income producing purpose, may claim all of the interest expense as a deduction.

It states at paragraphs 12 and 13:

12.  In certain cases, such as Carberry, a single asset (such as land with a single title) may be capable of being properly regarded as having been notionally divided between a part acquired with a business purpose and a part acquired with a non-business purpose.  In such a case, borrowings may be properly regarded as relating to the notional part of the asset acquired for a business purpose and a deduction will be allowed for the full amount of interest paid in respect of the borrowings.

13.  However, for this method of apportionment to apply, it must be shown that the borrowings in fact relate solely to the notional part of the asset acquired for business purposes.  In Carberry, for instance, the taxpayers were able to show that the part of the asset purchased for private purposes was paid for with the monies which the taxpayers had received from the sale of their previous residence.

In your case you will own a property which is registered with two units on it, where one unit is rented out on a commercial basis and the other unit is used as your residence. It is considered that your property can be notionally divided between the residence and business premises.

You will have two different loans of equal amounts for the two dwellings, so that the borrowings which relate solely to rental property can be isolated from the other borrowings.

The following factors were taken into account in arriving at this conclusion:

The two units are, for practical and valuation purposes identical, and this enables the total purchase price to be halved into the two separate loans.

You will use the proceeds of the sale of your previous residence to pay for the part of the property used for your principal private residence.

As the proceeds of the loan for the rental part of the property relate wholly to the income producing part of the property, a deduction for this loan is allowed under section 8-1 of the ITAA 1997 for the full amount of the interest.

A deduction for any of the interest on the loan which relates to the unit which is your principal place of residence is non-deductible under section 8-1 of the ITAA 1997.

The rate at which you repay the loan for your principal place of residence will not affect the loan for the other unit which is for investment purposes.

The proceeds for the separate loan which relates to the unit which is your principal place of residence make this loan non-deductible under section 8-1 of the ITAA 1997 to the extent that it is of a capital, private or domestic nature.

Main Residence Exemption

A capital gain or capital loss from a CGT event that happens to your ownership interest in a dwelling that is your main residence is generally disregarded (section 118-110 of the ITAA 1997).  

To be fully exempt from CGT:

The dwelling must have been your home for the entire period you owned it;

The dwelling must not have been used to produce assessable income; and

Any land on which the dwelling is situated must be two hectares or less. 

In your case, if the unit is your main residence for the entire period you own it you will be entitled to disregard the entire capital gain on the portion of the sale price relating to that unit when you dispose of the property. We note that on the existing title you will not be able to sell either unit on its own.