Edited version of your private ruling

Authorisation Number: 1012449308303

Ruling

Subject: Rental property

Question

Are you entitled to a deduction for the interest expenses you incur on your borrowed funds used to acquire a share of an investment property from your spouse?

Answer

Yes.

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

Year ended 30 June 2017

The scheme commenced on

1 July 2012

Relevant facts

Your spouse owns a rental property.

You wish to purchase 50% of the ownership of the property from your spouse.

You have obtained a market valuation of the property and will pay 50% of the market value to your spouse.

You will borrow funds from a bank to purchase your share of the property.

The title deed will be changed to show you as joint owner.

The property is rented through a real estate agent.

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 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.

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which assessable income is to be derived, the interest incurred on the loan will generally be deductible. 

Taxation Ruling IT 2167 examines the situation where a property is let to relatives and non arms length transactions. Although you are not letting to relatives, you are dealing with a related party when purchasing the property, and therefore the principles outlined in this ruling are relevant. Where a person is dealing with relatives, the essential question is whether the arrangements are consistent with normal commercial practices. Where the arrangement is not at arms length, an apportionment of losses and outgoings incurred is generally required.

The test that should be considered to show whether the arrangement is at arms length, is whether a reasonable person with no relationship to either party would enter into this arrangement using exactly the same terms and conditions. If the answer is yes, then it would be an arms length arrangement. Whether parties are at arm's length is a question of fact.

In your case you are purchasing a share in a rental property from your spouse. As you are paying market value for the property and the title deed will be changed to reflect your ownership interest, it is considered that you are dealing at arm's length and the arrangement is commercially realistic.

Therefore, as your borrowed funds are being used to acquire an investment property for income producing purposes, the associated interest expenses are an allowable deduction. The fact that you are purchasing the property from your spouse does not change the deductibility of the expense in your specific circumstances. The interest expenses incurred are an allowable deduction under section 8-1 of the ITAA 1997.