Private ruling: Rental deductions
Published: February 2013
Ruling period: Year ended 30 June 2013 | Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for the interest expenses you will incur? | A1: No.

Relevant facts and circumstances: You live in house A. You want to mortgage house A and build house B. You then want to move into house B and rent out house A. There will be no mortgage on house B.

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 (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 deals with the general principles governing deductibility of interest under section 8-1 of the ITAA 1997. To establish that there is a sufficient connection between incurring an interest expense and the gaining or producing of assessable income, regard must be given to all the circumstances including the use to which the borrowed funds are put. 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 to the application of the borrowed funds as the main criteria. Where borrowed funds are used for private purposes, such as the acquisition of a home, the interest will not be deductible even if there is a secondary result that other assets are able to be retained for the purpose of producing assessable income. The 'use' test was relied upon by the Board in its decision of Case B11 , 70 ATC 46 ( Case B11 ). In that case, the taxpayer purchased a new home with borrowed money, having decided to retain ownership of his former home with a view to leasing it. The former home was let to a tenant for a term commencing at about the same time that the taxpayer vacated it and took up residence in his new home. The taxpayer's claim for a deduction against the rent received for the interest paid on the borrowed money was disallowed. It was held that the borrowed money not only enabled the taxpayer to retain his former home for income-producing purposes but also to acquire ownership of a new house as a family residence. Although it would not have been possible to achieve both these results without borrowing, no apportionment of the interest paid is possible as the deductibility of interest depends directly and only on the use to which the principal is put. In your case, you currently live in house A. You intend to mortgage house A and build house B. You will subsequently move into house B and rent out house A. Your case can be compared to that of Case B11 in that the use of the money raised from the equity in your current residence will be used for the purpose of building a new primary residence which is of a private purpose and not an income-producing purpose. Accordingly, as the borrowed funds will not be used for income-producing purposes, you are not entitled to a deduction for the interest expenses you will incur.

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