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Ruling

Subject: Purchase of property from spouse for rental

Question

Are you entitled to a deduction for interest incurred on a loan used to purchase your spouse's property?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You and your spouse each own a separate property entirely in your individual names.

Each of you wishes to purchase the other's property. You and your spouse have had the properties valued and intend to rent the properties using a real estate agent.

You would be applying individually for bank loans to purchase each property.

Following the sales, the proceeds would be used by you both to pay off any current debt on the properties, and the balance used by you both for the purchase of a 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) allows a deduction for all losses or 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 in nature or are necessarily incurred in gaining or producing exempt income.

The general principles relevant to the deductibility of interest expense are set out in Taxation Ruling TR 95/25. This Ruling provides that interest expense is incurred in gaining or producing assessable income and is not of a capital, private or domestic nature if it has a sufficient connection with the operations or activities which more directly gain or produce the taxpayer's assessable income and not be of a capital, private or domestic nature. The test is one of characterisation and the essential character of an expense is a question of fact to be determined by reference to all the circumstances.

The character of interest on a loan is generally ascertained by reference to the purpose of the loan see Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 and the use to which the loan is put see Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153. Therefore, if a loan is used to purchase property from which income is to be derived, the interest paid on the loan is generally deductible.

Taxation Ruling TR 95/33 requires an examination of all the circumstances surrounding the expenditure to ensure that the interest expense could be properly characterised as genuinely, and not colourably, incurred in gaining or producing the assessable income.

In your case, you intend to use a loan to purchase your spouses property at market value for the purpose of deriving rental income.

Therefore, it is irrelevant that you will acquire the property from your spouse. Accordingly, a commonsense or practical weighing of all of the factors could be expected to lead to the conclusion that the relevant interest expense is properly to be characterised as genuinely, and not colourably, incurred in gaining or producing assessable income.

Therefore, you are entitled to a deduction, under section 8-1 of the ITAA 1997, for the interest payments on a loan, where the proceeds of the loan will be used to purchase your spouse's property, at market value, for the purpose of deriving rental income.