Edited version of private advice

Authorisation Number: 1051989551105

Date of advice: 18 November 2022

Ruling

Subject: Rental loan deductions

Question 1

Is the interest expense you incurred on the loan for the purchase of Property A fully deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the interest expense you incurred on the loan for the purchase of the Property B fully deductible under section 8-1 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You and your spouse have the following properties:

•         Property A

•         Property B

•         Property C

•         Property D

Property A was purchased by you and your spouse a couple of decades ago.

Several years ago, the loan was restructured.

This property has always only been a rental property and is rented at this point in time by you and your spouse.

Property B was purchased by you and your spouse a couple of decades ago.

Several years ago, the loan was increased to fund the purchase of Property C.

A few years ago, the loan was restructured the property was a rental at this time.

It was you and your spouse's main residence for a few years after the restructure.

It has been rented out after that period until the present day.

Property C was purchased by you and your spouse at the time of the restructure of the Property B loan.

There has been no restructure on this loan.

This was your main residence at the time of the loan restructure

It was your main residence from for several years.

This property has been rented out for the last few years until the present day.

Property D was purchased by you and your spouse several years after the purchase of Property C.

The loan was restructured a few years later.

At the time of the loan restructure the property was being rented.

This property became you and your spouse's main residence at the time of the loan restructure and remains you and your spouse's main residence at this point in time.

No interest deductions have been claimed in relation to Property D since it became your main residence.

The loan restructures were done at the instigation of the bank to minimise the bank's exposure and spread the security more evenly across the properties.

The net loan position prior to the restructures and after the restructures remained the same with no additional cash drawdowns.

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 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 provides the Commissioner's view regarding the deductibility of interest expenses. As broadly outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income (paragraph 3(a) and paragraph 21). 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 (paragraph 3(b)).

Taxation Ruling 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities states:

6. The deductibility of interest is typically determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put (Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613, FC of T v. Energy Resources of Australia Limited 96 ATC 4536; (1996) 33 ATR 52, and Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139 (Steele)).

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. However, where a loan relates to private purposes, no deduction is allowed.

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 refinance. Paragraph 42 of TR 95/25 addresses borrowings used to repay an existing loan. The paragraph states "Interest on a new loan will be deductible if the new loan is used to repay an existing loan, which, at the time of the second borrowing, was being used in an assessable income producing activity or used in a business activity which is defined to the production of assessable income (Roberts and Smith ATC at 4388; ATR at 504).

Where you refinance and increase your loan borrowings it is only the amount of the borrowings that relates to income producing purposes that will be deductible under section 8-1. Paragraph 40 of TR 95/25 deals with apportionment, stating that where the amount of capital attributable to deductible purposes is less than the amount borrowed it will be necessary to apportion the interest expense. Taxation ruling TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities deals with the same principle and provides guidance on how to calculate apportionment for mixed purpose loans.

Application to your circumstances

Property A

Property A has only ever been used to produce income as a rental investment property since it was purchased up until the present day. This property has never been used as your main residence so there's no private or domestic use of the property. Therefore, the interest expense you incurred on the loan for the purchase of the property is fully deductible.

When the loan was restructured some of the borrowings were applied for private purposes. The interest that relates to the original borrowing amount will continue to be deductible for so long as Property A continues to be used to produce income. Any interest deduction will need to be apportioned accordingly.

Property B

Property B has been used to produce income as a rental property since it was purchased up until it became your main residence. For the prior decade, up until the date of the ruling application, the property is used to produce income again as a rental property. Therefore, the interest expense you incurred on the original loan for the purchase of the property is fully deductible in the income years the property is entirely used to produce income.

When the loan was restructured shortly afterwards, an additional amount was borrowed to contribute to the purchase of Property C, which was a rental property. At this time the additional funds were used for an income producing purpose and interest attributable to that part of the loan was deductible. The balance of the loan related to the Property B which had become your main residence and interest relating to this part of the loan was not deductible.

When the loan was restructured again more recently some of the borrowings were applied for private purposes. The interest that relates to the original borrowing amount will continue to be deductible for so long as Property B continues to be used to produce income. Property C is also used to produce income and interest that relates to this borrowing amount from the earlier restructure will be deductible for so long as Property C is used to produce income. Any interest deduction will need to be apportioned accordingly.