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Ruling

Subject: Rental property interest expenses

Question:

Will you be entitled to claim a deduction for your portion of the interest expense on loans used to refinance existing loans where the original loans were used to purchase income-producing assets?

Answer:

Yes.

This ruling applies for the following periods

Year ended 30 June 2012
Year ending 30 June 2013

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You and your partner purchased a property.

The property consisted of a house (House 1) on a block of land.

Two loans were used to finance the property. Both loans were in joint names.

House 1 has been rented since the time of purchase.

You built a second house (House 2) on the land.

The building of House 2 was financed by using your private funds.

House 2 was made available for rent during the 2010-11 financial year. Whilst you engaged a real estate agent to find a tenant for the house, you managed the house once it was rented during the 2011-12 financial year.

You have sub-divided the land into two blocks. Block 1 contains House 1. Block 2 contains House 2.

The local council have approved the subdivision and you will receive a rates notice for each block of land in the future.

You have applied to have separate titles created for each of the blocks. This process will be finalised during the 2012-13 financial year.

Once you have separate titles you will refinance the loans.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1
Taxation Administration Act 1953 Schedule 1 Section 359-5

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 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 or a provision of the taxation legislation excludes it.

Taxation Ruling TR 92/5 provides that the deductibility of interest is determined by the use to which the borrowed money is intended. The use test is the basic test for the deductibility of interest and looks at the application of the borrowed funds as the main criteria. Where the borrowed funds are used for the purposes of producing assessable income, a deduction will be allowed for the interest on the loan. This includes interest on loans used to acquire a rental property.

TR 95/25 goes on to state that interest on a new loan will be deductible if the new loan is used to repay an existing loan which, at the time of the second borrowing, was being used in an assessable income producing activity.

You and your partner borrowed funds to purchase House 1 on a block of land. You built House 2 on the block of land. Both houses are rented. You will be refinancing the original loans when the block of land is legally separated and each house appears on a separate title.

The interest expenses on the new loans are allowable deductions as they relate to the earning of assessable income. You will be entitled to your share of the interest expense on the existing loans prior to refinancing and the new loans.