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Ruling
Subject: Interest on loan for principal residence
Question
Are you entitled to a deduction for the interest on a loan borrowed against the equity in your rental property and used to finance your new principal place of residence?
Answer
No.
This ruling applies for the following periods
Year ended 30 June 2013
Year ended 30 June 2014
Year ended 30 June 2015
Year ended 30 June 2016
The scheme commenced on
1 July 2012
Relevant facts and circumstances
You are the owner of a rental property which was previously your principal place of residence.
You have relocated interstate for work reasons and have recently purchased your new principal place of residence.
Your former principal place of residence remained empty for some time after you moved out, and has now been rented for several months.
You own your rental property in full, with nothing owing on it.
You wish to take the equity from your rental property which was formerly your principal place of residence and use it to purchase a new house to live in.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income.
Taxation Ruling TR 95/25 considers the deductibility of interest. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. The interest will be deductible to the extent that the property is used to produce assessable income.
It is considered that a repayment to a loan account is a permanent reduction to this debt. Repayments of an amount to a loan do not create a debt due to the borrower. It simply allows the borrower the right to then draw funds to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant.
In applying the use test, the character of the interest on the money borrowed under a new loan will not have sufficient connection with the operations or activities involved in gaining your assessable income as it will not be used to acquire an income producing asset. The money borrowed will be used for a private purpose, that is, to purchase a property in which you will reside.
Accordingly, as the loan will be for the purchase of a private home, it is considered to be a private expense and you are not entitled to a deduction.