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Edited version of your written advice
Authorisation Number: 4110063932471
Date of advice: 18 January 2019
Ruling
Subject: Deductibility of interest for a rental property
Question
Is the mortgage interest tax deductable, on a loan used to repay your relative for money borrowed from them originally to assist in the purchase of an investment property?
Answer
Yes
This ruling applies for the following periods:
Year ending 30 June 2019
Year ending 30 June 2020
Year ending 30 June 2021
Year ending 30 June 2022
The scheme commences on:
2018
Relevant facts and circumstances
You purchased an investment property in the year ended 30 June 2018.
The purchase price plus legal fees, rates and any other associated costs with the settlement were made available made up of:
● A small deposit of your own funds.
● A sizeable gift from a family member.
● The balance provided as a loan from your family member.
You have a notarised agreement in place with regards the repayment of the loan to your family member whereby you would get a mortgage on the property to repay the full amount of the loan.
A mortgage was secured on during the year ended 30 June 2019 to repay your family member as part of your agreement to purchase the property.
The property was made available for rent during the year ended 30 June 2018.
The property is currently rented on a commercial basis.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 8-1
Reasons for decision
Under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income. However, you cannot deduct a loss or outgoing to the extent that it is of a capital, private or domestic nature.
If a loan is taken out to purchase a rental property, the interest charged on that loan, or a portion of the interest, can be claimed as a deduction. The property must be rented, available for rent, or intended to be rented in the immediate future, in the income years for which the deduction is claimed. Rental deductions can be claimed against the receipt of rental income as expenses incurred in earning assessable income under section 8-1 of the ITAA 1997.
The general principles relevant to the deductibility of interest expense are set out in 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. The test is one of characterisation and the essential character of an expense is a question fact to be determined by reference to all the circumstances.
The character of interest on a loan is generally ascertained by reference to the purpose of the loan (Fletcher & Ors v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 (Fletcher's Case)) and the use to which the loan is put (Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153 (Munro’s Case)). Therefore, if a loan is used to purchase property from which income is to be derived, the interest paid on the loan is generally deductible.
Taxation Ruling TR 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings requires an examination of all the circumstances surrounding the expenditure to ensure that the interest expense could be properly characterised as genuinely, and not colourably, incurred in gaining or producing the assessable income. Interest may be incurred on loans for more than one purpose, in which case it may be necessary to apportion the interest payments for calculating deductibility of the interest.
In your case your family member loaned you an amount to purchase a property. This has been substantiated by a notarised agreement stating the loan will be repaid when you secured a mortgage from a bank over the property.
The arrangement you made is equivalent to a refinance situation.
Therefore, as the mortgage has been secured for the sole purpose of funding the acquisition of the rental property the interest will be deductible as it is incurred in gaining or producing your assessable income.