Edited version of private advice

Authorisation Number: 1051684943465

Date of advice: 25 May 2020

Ruling

Subject: Rental interest expenses

Question

Are you entitled to claim a deduction for your share of interest incurred on the loan that was used to purchase your rental investment property?

Answer

Yes

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.

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 (Munro's case), 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.

This remains so even where you change the security for the loan. The deductibility of interest is determined by the use for which the borrowed money is intended and not by the security given for the borrowed money (Taxation Determination TD 93/13). The nature of the security (if any) given for the loan is irrelevant in determining the deductibility of interest (Munro's case). The security is simply a surety to your financier in the case of default of the loan and does not alter the use of the loan funds.

This use is also not altered in the case of a re-finance. Taxation Ruling TR 95/25 examines, amongst others, this circumstance. Interest on a new loan which was used to repay an existing loan will be deductible if, at the time of second borrowing, the fund was being used in an assessable income producing activity.

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.

In your case, the loan was taken out for two purposes, one for your investment property and one for your investment property. It is necessary to apportion the interest payments incurred for each entity's tax return.

Having considered your circumstances, the commissioner accepts that you are entitled to a deduction for your apportioned interest expenses under section 8-1 of the Income Tax Assessment Act 1997.

This ruling applies for the following period:

Year ended 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

You are joint owners of the property with your spouse.

You purchased this property in 20XX.

You had put down a deposit and needed finance.

You spent months trying to obtain finance and engaged a broker to help you.

You were unsuccessful in obtaining a lender using the property as security, so it was decided to use your family home.

In 20XX you increased the loan to complete renovations.

You refinanced the loan in 20XX to include another investment property.

Your loan was refinanced.

Your family home at XXXX is held as security and prior to the refinance your home was debt free.

Your rental property is tenanted and earning assessable income.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1