Edited version of private advice

Authorisation Number: 1051612840331

Date of advice: 26 November 2019

Ruling

Subject: Deductibility of loan interest

Question 1

Are you entitled to a deduction for the full amount of loan interest incurred on the new investment loan?

Answer

No.

Question 2

Are you entitled to a deduction for the amount of loan interest incurred on the remainder of the loan of $X for property A that was refinanced as part of the new investment loan?

Answer

Yes.

Question 3

Are you entitled to a deduction for loan interest incurred from the time property A was genuinely available for rent?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased a property (property A) and borrowed $X from a bank to assist with the purchase.

You lived in property A for approximately XX months before placing it on the market and looking for another property to purchase as your next home.

You purchased another property to live in (property B).

You were unable to sell property A and decided to rent it out.

You refinanced the original loan for property A and obtained funds for the purchase of property B by obtaining two new loans from a bank which were secured by both properties. These loans were an 'investment' loan of $Y which you say related to property A and a 'home' loan of $X which related to property B.

You rented out property A through a real estate agent within a few weeks of moving into property B.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Deductibility of loan interest

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for 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 (TR 95/25) provides the Commissioner's view on 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 income is to be derived, the interest incurred on the loan will be deductible. Further, interest on a new loan used to repay an existing investment loan will generally also be deductible as the character of the new loan is derived from the original borrowing.

That is, when a loan is refinanced, the new loan takes on the same character as the previous loan. Refinancing a loan does not in itself break the nexus between the outgoings of interest under a loan and the income earning activities.

Where borrowed funds are used for private purposes, such as the acquisition of a private home, the interest will not be deductible.

Taxation Determination 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. The choice of assets used as security for a loan is not relevant and interest deductibility is determined by the use of the borrowed money.

In your case, you purchased a new property to live in and rented out property A. You refinanced the original loan for property A and obtained funds for the purchase of property B by obtaining two new loans from a bank; an 'investment' loan of $Y which you say related to property A and a 'home' loan of $X which related to property B.

Even though you refinanced the remaining portion of the original $X loan relating to property A, the borrowed funds are still being used for income producing purposes. Accordingly, you are entitled to a deduction for interest incurred on the funds used for investment purposes after you refinanced the loan.

However, the use of the 'investment' loan funds in excess of the remaining portion of the original $X loan was to fund the purchase of your new private residence, which is private in nature and not related to an income producing purpose, notwithstanding the loan being classified as an investment loan.

Accordingly, as the character of the new borrowing of $Y in excess of the remaining portion of the original $X loan is private and is not used for income producing purposes, you are not entitled to a deduction for that portion of the interest incurred on the loan.

Property genuinely available for rent

You can claim a deduction for certain rental expenses you incur for the period your property is rented or is available for rent.

Expenses may be deductible for periods when the property is not rented out providing the property is genuinely available for rent; that is:

·         the property is advertised in ways which give it broad exposure to potential tenants, and

·         having regard to all the circumstances, tenants are reasonably likely to rent it.

In your case, you can claim a deduction for rental expenses, including loan interest, from the time your property was genuinely available for rent in the hands of the real estate agent if this time preceded the date the tenants first moved in.