Private ruling: Reverse mortgage loan - interest
Ruling period: Year ended 30 June 2010 | Year ending 30 June 2011
Date scheme commenced: 1 July 2005

Ruling: Q1: Are you entitled to a full deduction for interest incurred on a reverse mortgage loan where the funds are used for investment purposes? | A1:  | Q2: Are you entitled to a partial deduction for interest incurred on a reverse mortgage loan where the funds are used for investment purposes? | A2: 


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 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. Whether interest has been incurred in the course of producing assessable income generally depends on the purpose or use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is generally considered to be incurred in the course of producing assessable income: Taxation Ruling TR 95/25. In your case all of the funds borrowed have been used to derive assessable income, up until the point shares were sold and the proceeds used to purchase a private use item. To determine the extent of which interest remains income related after the sale of the shares to purchase a personal use item, interest after this time would need to be reduced by multiplying it against the following figure: Funds borrowed - cost of shares Funds borrowed However, your entitlement to an interest deduction is further limited for reasons noted below. The High Court in Fletcher v. Federal Commissioner of Taxation (1991) 173 CLR 1; 91 ATC 4950; (1991) 22 ATR 613 ( Fletcher's Case ) considered the circumstances where the interest outgoings of a taxpayer exceeded the assessable income relevant to this expense. It was found that where the assessable income derived from an arrangement is less than the relevant outgoings and the facts lead to the conclusion that there is another objective for incurring the expense, only part of the outgoing is an allowable deduction. The court found it was fair and reasonable to limit the deduction of the amount of income actually received. In your situation, you have received a return of capital and invested the funds into the purchase of shares that provide dividend income. You are currently incurring an interest expenses on the invested funds. Your circumstances are consistent with those examined in Fletcher's Case as the amount of interest incurred on the borrowing will exceed the amount of assessable income derived from the share, indeed this disparity will increase with the compounding of the borrowing under the reverse mortgage. As it is clear the arrangement is not commercially viable, it is reasonable to conclude an objective other than the single pursuit of earning assessable income exists. Therefore, after reducing your interest to take into account the purchase of the personal use item (see above) the remaining interest is only deductible to the extent of the dividend income received from the shares purchased with the reinvested funds. For the year ended 30 June 2010, this means you can only claim the equivalent of the amount of related dividend income you derived.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns. | Answer: Yes (as identified below). | Relevant facts: You and your spouse accepted an offer to enter into a loan contract with a credit provider. | The credit provider appointed a mortgage manager to manage your loan contract and the securities. | The loan type offered was a reverse mortgage loan; the borrowing is secured by your primary residence. | You must make one repayment on whichever of the following happens first: | · the mortgage property is sold or transferred | · the day which is 90 days after you die or, if there is more than one of you, after the last one of you dies. | Your spouse has since passed away. | The borrowing is fixed for 10 years, when the fixed rate term expires the loan will default to the residential variable rate. The full amount of funds was invested in order to fund your retirement. | The interest is calculated daily and charged to your borrowing on the first business day of the month, and you receive half yearly loan statements. | Your investment failed and you have received a partial return of capital. | You have reinvested the return of capital into shares that provide dividend income. A portion of these funds were subsequently used for private purposes.