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Edited version of your written advice
Authorisation Number: 1051485159630
Date of advice: 25 February 2019
Ruling
Subject: Rental property loan interest
Question
Are you entitled to a deduction for your share of the interest you incur on a property loan which was established after the original loan was finalised?
Answer:
No
This ruling applies for the following period
Year ended 30 June 2018
The scheme commenced on
1 July 2017
Relevant facts
You are a joint owner in a rental property.
You have used you family home as security for the investment loan on this property.
When you sold your family home to build a new home, you were advised by your bank to pay out your investment loan using the funds from the sale of the family home, and then create a new loan when your new home was built.
The bank would not take the investment property as security and the block of land you brought did not have enough equity or value to change over the security at that time.
Now your new home is built and your loans are structured as they were, that is a portion for your family home loan and portion for the investment loan, you have been advised that you can no longer claim the interest for the investment loan as it is a new loan.
Your accountant has stated that your investment property is fully paid out; however you were advised by your bank that it was a short term closure of the loan for restructuring with new security.
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.
Taxation Ruling TR 95/25 provides that the deductibility of interest is determined by the use for which the borrowed money is intended. 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 for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. Paragraph 29 of TR 95/25 states:
In FC of T v. Munro (1926) 38 CLR 153 ( Munro ) the High Court considered whether interest incurred on a borrowing which was not used to produce assessable income, but was secured by an income producing asset, was deductible. The taxpayer argued that if the interest obligations were not discharged, the income producing asset that secured the borrowing would be in jeopardy. Thus, the discharge of the obligation to pay interest was incurred in producing assessable income. The High Court rejected this proposition.
Taxation Determination TD 93/13 also considers the relevance of security provided for a loan and establishes the principle that deductibility is determined by the use of the borrowed money and the choice of assets used as security for a loan is irrelevant. TD 93/13 examines the situation where a non-income producing asset is used as security for a loan to purchase an income producing asset. The interest is deductible because of the use to which the borrowed money is applied. Equally, where an income producing asset is used as security for a loan to purchase a non-income producing asset the interest will not be deductible.
In your case, the purpose and use of the new loan will be to fund the purchase of your new private residence, which is private in nature and not related to an income producing purpose, notwithstanding your bank’s requirement to initially reduce the borrowing.
The connection between an income producing asset and the debt has been lost, as you cannot borrow to buy an asset that you already own.
Accordingly, as the character of the new borrowing is private and will not be used for income producing purposes, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for the interest incurred on the loan.