Edited version of your written advice

Authorisation Number: 1012717972351

Ruling

Subject: Interest expenses

Question

Are you entitled to a deduction for interest incurred on a loan following the sale of a former rental property where the property was used as your residence prior to sale?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You purchased an investment property.

You financed the entire purchase of the property through a loan facility.

You placed the property on the market.

Whilst the property was for sale, you were unable to tenant the property as you wanted to have the property presentable for sale, did not want to deter any purchaser by entering into an extended lease and found it difficult to find tenants to rent a property that is currently listed for sale without a long term lease.

As you could not afford to have the property vacant, you moved into the property and rented out your previous place of residence.

During the time you resided in the property it has always been on the market.

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, or relate to the earning of exempt income.

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.

Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v. Roberts; FC of T v. Smith states that interest on borrowings will not continue to be deductible if the borrowed funds cease to be employed for an income producing activity. It is not considered that the nature or use of the borrowed funds can be notionally altered or amended at a future time.

In your situation you borrowed money to purchase a property which was being used as a rental property. While the property was producing assessable income the interest would be deductible under the use test. However, once the property ceased being a rental property and you moved into the property and used it as your principal place of residence, the use to which the borrowed funds have been put has become private in nature and the interest is no longer deductible. Therefore, where the property is your principal place of residence prior to sale, you are not entitled to a deduction for the interest incurred following the sale of your rental property under section 8-1 of the ITAA 1997.

Further issues for you to consider

You referred to Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities in your private ruling. However, we consider that your case is distinguished from the circumstances examined by the ruling as the connection (or nexus) between the outgoing and your income earning activities has been broken by your use of the property for non-income producing purposes. Therefore, the outgoing is no longer associated with the former income earning activities as you are no longer making an attempt to earn assessable income in connection with which the debt was originally incurred.