Edited version of your private ruling

Authorisation Number: 1012475484949

Ruling

Subject: Interest on property loan where amounts redrawn prior to income production

Question 1

Is the interest incurred on the loan balance outstanding at the time your principal place of residence became an investment property all taken to be for investment purposes?

Answer

No.

Question 2

Do you have to apportion the interest incurred on your property loan to take into account the amounts redrawn for non income producing purposes before it became a rental property?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You lived in your home as a principal place of residence (PPR) from when you purchased it, until you relocated interstate and rented the property.

You had a redraw facility on your loan which you used.

While the property was your PPR you were not required to keep records in relation to the loan, or any amounts redrawn and the purpose for which they were redrawn.

The loan balance at the time you rented the property enabled you to use it as an income producing asset, rather than sell it to settle the loan.

You have continued to use the redraw facility since you rented the property out, and since then have treated the loan as a mixed purpose loan and apportioned the interest in accordance with the uses to which the amounts redrawn have been used, whether for an income producing purpose or private purpose.

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) provides that a deduction is allowable for expenses incurred in gaining or producing assessable income, provided those expenses are not capital, private or domestic in nature.

The principles in relation to the deductibility of expenses incurred in gaining or producing assessable income have been established through the views taken by the Courts, Boards of Review and Administrative Appeals Tribunals.

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 criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income.

In your case, the amount outstanding on the loan for your PPR fluctuated due to your repayments and further withdrawals under your redraw facility.

Because of this, at the time you changed the purpose of the residence to income producing, the outstanding balance of the loan did not reflect the amount originally borrowed to purchase the property. This amount would vary depending on the terms of the loan, and any repayments you had made.

Taxation Ruling TR 2000/2 contains the Commissioner's view on the deductibility of interest with regards to line of credit and redraw facilities. We consider a draw-down from a line of credit account or sub account, or a redraw from a loan account, is a separate borrowing. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible. Conversely, that part of the accrued interest attributable to borrowings for non-income producing purposes is not deductible.

This applies to your loan for your PPR to the extent that the balance of the loan owing at the time the residence became income producing was different than it would have been if you had not redrawn amounts from it.

Therefore, it will be necessary for you to reconstruct the withdrawal transactions on your property loan while the property was your PPR, as no deduction is allowable under section 8-1 of the ITAA 1997 for the interest incurred on the part of the loan which is not related to the purchase of the property.

Please note: it is acknowledged that you were not required to keep records while the property was your PPR.

In order to reconstruct the balance owing to take into account the redrawn amounts when the purpose of the loan changed you may be able to access bank records.

While the property has been mortgaged, it would be reasonable to expect that your lending authority would retain records of transactions on the loan account.