Private ruling: Rental property interest expenses
Published: December 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Can you claim a deduction for interest expenses incurred on a loan taken out to purchase a principal residence? | A1: No

Relevant facts and circumstances: You purchased an investment property during the relevant financial year. Your principal place of residence was used as security against the loan taken out to purchase the investment property. During the subsequent financial year you decided to sell your principal residence and move into your investment property. Your financial institution advised that as your principal residence was the security for the loan on the investment property you would be expected to use the sale proceeds to pay out the loan. Although you wished to maintain the investment loan, your financial institution advised this was not possible and the loan was paid in full from the sale proceeds of your principal residence. You then moved into your investment property. You subsequently decided to purchase another main residence. You were advised that if you took out a loan equal to the amount remaining on the original loan when it was paid out you could still claim the interest. Your tax agent then advised that this was not correct and no more interest is deductible in respect of the investment property.

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

Reasons for decision: Summary: Interest is deductible under section 8-1 of the Income Tax Assessment Act 1997 ( ITAA 1997) to the extent that it is incurred in gaining or producing assessable income or in carrying on a business for that purpose, except to the extent that the expense is of a capital, private or domestic nature or incurred in gaining or producing exempt income. Taxation Ruling TR 95/25 provides that the deductibility of interest on borrowed funds is determined by the use of the borrowed money. The use test, established in FC of T v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest and looks at the application of the borrowed funds as the main criterion. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. You originally took out a loan to purchase a rental property. The loan was completely paid out when you sold your original main residence and moved into the rental property. You then purchased a new primary residence by way of two loans, one of which was for the amount paid out on the investment property loan. Although you have raised a loan equal to the outstanding amount of the loan which was paid out from the proceeds of the sale of your main residence, you cannot purchase the same property twice. Hence when you paid out the investment property loan, your ability to claim any interest in relation to the purchase of that property was extinguished. While it is accepted that the original funds were used to fund the purchase of a rental property, the new funds will be used for the purchase of a primary residence. As such, the use of the funds is considered to be of a private nature. Therefore, you are not entitled to a deduction for interest.

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