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Ruling
Subject: Loan interest
Question
Are you entitled to a deduction for interest on the funds that were used to finance your new private residence?
Answer
No
This ruling applies for the following period
Year ended 30 June 2012
The scheme commenced on
1 July 2011
Relevant facts
You purchased a rental property (house A) which was fully mortgaged.
The loan was secured against a proportion of your principal place of residence (house B), which you owned fully, and the rental property.
You later decided to sell house B and purchase another house to live in (house C).
As the settlement on your new home would occur before you sold house B, you needed another short term loan for the interim.
You then had two loans, one for house A, and one for house C.
When settlement took place on the sale of house B, the bank applied a portion of the proceeds against the loan for house A, leaving a balance which was the new limit they put on that loan.
You then transferred funds from another account to the new loan, which reduced it.
You wanted to tidy up the accounts so you then transferred funds from the new loan to the loan for house A, which reduced it to nil, and increased the amount of the new loan for house C.
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) allows a deduction for all losses and outgoings, including interest, 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 95/25 looks at the deductibility of interest. It states that the deductibility of interest depends upon satisfying, or being able to show, that the expense has sufficient connection with the operations or activities which directly gain or produce a taxpayers assessable income. In other words, the interest must be incurred in relation to assets which are held for income producing purposes.
Taxation Ruling TR 95/25 provides that the deductibility of interest is determined by the use for which the borrowed money is put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153 (Munros Case), is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income.
In your case your bank initially applied some of the proceeds from the sale of your private residence to the reduction of the loan on your rental property.
You then deposited an amount from another account which reduced your rental property loan to nil.
While the circumstances of your case produced an unfortunate result, the fact remains that the debt owing on your rental property has been repaid in full.
The current loan has not been applied to an income-producing purpose. Under tax law any borrowing that is not made for an income producing purpose is considered private in nature and the interest incurred is not deductible under section 8-1 of the ITAA 1997.
Therefore, the interest you will pay on the current loan amount will not be deductible under section 8-1 of the ITAA 1997 as the borrowed funds were used solely for the private purpose of purchasing a new private residence.