Private ruling: Property expenses
Published: July 2013
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for X% of the interest expenses on loan A and B when the property is only partly rented? | A1: No. | Q2: Are you entitled to a deduction for X% of the interest expenses on loan A and B that relate to the rented house while it is jointly owned and rented? | A2: Yes. | Q3: Are you entitled to a deduction for the interest expenses on loan C that relates to the refinancing of your previous income producing portion of loan A? | A3: Yes. | Q4: Are you entitled to a deduction for the remainder of your interest expenses on loan C? | A4: No. | Q5: Are you entitled to a deduction for Y% of the water and council rates incurred for the period the property is jointly owned and rented? | A5: Yes. | Q6: Are you entitled to a deduction for X% of the water and council rates incurred on the property when you are the sole owner? | A6: Yes. | Q7: Are you entitled to a deduction for X% of the remaining borrowing expenses relating to the income producing portion of the discharged loans A and B? | A7: Yes. | Q8: Are you entitled to a deduction for the income producing portion of the borrowing expenses of loan C? | A8: Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 25-25

Reasons for decision: Summary: 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. A number of significant court decisions have determined that for an expense to be an allowable deduction: · it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense ( Lunney v. FC of T ; (1958) 100 CLR 478 ( Lunney's case )), · there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. FC of T , (1949) 78 CLR 47), and · it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income ( Charles Moore Co (WA) Pty Ltd v. FC of T , (1956) 95 CLR 344; FC of T v. Hatchett , 71 ATC 4184). 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. The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. 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. Furthermore, 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. | Detailed Reasoning - Loans A and B: In your case, you originally had two loans for the purchase of the property. Loan B was used solely for the property purchase. Some of the funds from your loan A were used for private purposes. The original purchase price from the property includes the land where the structure is now built. As the structure is used for private purposes and not income producing purposes, the portion of the original loans that relate to the land for the structure is not an allowable deduction. One way to calculate the portion that relates to the structure land is to calculate the percentage of the valuation of the unimproved land that relates to the structure. For example, where the unimproved land value is $50,000 and the area devoted to the structure is half of the total property, then $25,000 of the original purchase price relates to private purposes. The remaining purchase price relates to the land and house being rented. It is the portion of the interest expenses incurred for the income producing house that is an allowable deduction. As you were a X% owner of the property for the relevant period, you are entitled to X% of the income producing portion of each of loan A and B. | Detailed Reasoning - Loan C: Your new loan C was used partly to refinance your previous jointly held loan A following your separation. In borrowing funds to discharge loan A, it is considered that the income producing portion of this loan as calculated above is an allowable deduction. That is, the funds used to discharge the income producing portion of loan A is an allowable deduction. However, the remaining funds of loan C are not used for income producing purposes and are therefore not deductible. The funds used to discharge the loans and credit card debts relating to the structure are private in nature and no deduction for the associated interest is an allowable deduction. Family Court matters are regarded as being private in nature. The funds borrowed to pay your spouse as per the court order is of a private nature and is not incurred in earning your assessable rental income. The remaining funds also relate to private purposes and interest on this amount is also not deductible. Therefore, the interest expenses on these parts of the new loan C are not deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Repayment of loan C: Taxation Ruling TR 2000/2 considers the deductibility of interest incurred by borrowers on mixed purpose loans. Where repayments are made on a mixed purpose loan, the repayments relate to both parts of the loan. That is repayments can not be made solely to the non-income producing portion. For example, if a loan is used 70% for income producing purposes and 30% private purposes, any repayments reduce the whole amount of the loan in the same proportions. That is, where no further funds are redrawn, the loan remains 70% deductible. | Detailed Reasoning - Water and council rates: Water and council rates are an allowable deduction where a property is used solely for income producing purposes. As the water and council rates to your property relate to a rental house and your main residence it is considered that the associated costs should be apportioned. In such circumstances it is generally fair and reasonable to apportion such costs equally to each dwelling. For the period when you were a joint owner and the house is rented, the joint owners are entitled to a deduction for X% of the water and council rates associated with the charges that relate to the rental house. Therefore you are entitled Y% of the total costs for this period. For the period when you are sole owner of the property, you are entitled to a deduction for X% of the total water and council rates that is the portion that relates to the rental house. Water and council rates for the structure are not an allowable deduction. | Detailed Reasoning - Borrowing expenses: Section 25-25 of the ITAA 1997 allows a deduction for expenditure incurred in borrowing money to the extent that the money is used for the purpose of producing assessable income. Where your total borrowing expenses are more than $100, the deduction is spread over five years or the term of the loan, whichever is the less. If you repay the loan early and in less than five years, you can claim a deduction for the balance of the borrowing expenses in the year of repayment that relate to income producing purposes. In your case, as only part of the borrowed funds relate to the rental home, then it is only the relevant portion of your share of the balance of the borrowing expenses for the discharged loans A and B that are deductible. For loan C, as you obtained the loan part way through the income year, the deduction for the relevant income year needs to be apportioned according to the number of days in the year that you had the loan. Please note it is only the income producing portion of the borrowing expenses that are an allowable deduction. Borrowing expenses relating to the structure and other private loan funds are not an allowable deduction.

Relevant facts: You and your spouse purchased a property as joint tenants. | The property was subject to two mortgages. Both loans were in joint names. | After purchasing the property and paying stamp duty and other associated costs, there were funds remaining. This amount was used for private purposes. | The property was rented for a period of time before you and your spouse moved into the property. | You and your spouse then commenced construction of a structure in the backyard of the property. | You and your spouse took out several personal loans and made purchases on credit cards to fund the construction of the structure. | The structure is on the same title however, the house and the structure are divided by fencing. Both have their own yards. | You and your spouse then moved into the structure and leased out the house. The house is leased through a real estate agent. | You and your spouse later separated. | After separation you retained the property and effectively bought your spouse's share of the property. | You were required to pay and discharge the joint loan A. Your spouse was required to pay and discharge joint loan B. | You took out loan C to discharge loan A, to pay the various joint debts associated with the structure construction as well as pay your spouse an amount of money as per the consent orders. | You are now the sole owner of the property. | You are residing in the structure. The structure has never been rented or used for income producing purposes. | The house is still rented.