Private ruling: Income tax - deductions - rental property expenses - interest expenses
Date of advice: 29 March 2018
Published: June 2018
Ruling period: Year ended 2016 | Year ended 2017 | Year ended 2018
Date scheme commenced: 01 July 2015

Ruling: Q1: Are you entitled to claim a deduction for interest incurred to acquire your former partner’s half share of Property A? | A1: Yes. | Q2: Are you entitled to claim a deduction for interest incurred to discharge your mortgage liability on rental Property B? | A2: No.

Relevant facts and circumstances: You and your partner jointly owned two properties: ● The principal place of residence (Property A); and ● An investment property (Property B). You and your partner borrowed funds to acquire these properties. You separated from your partner. You and your partner vacated your principal place of residence (Property A) just after separation when it was leased as an investment property. The Family Court of Australia approved your application for Consent Orders. You provided a copy of the Agreement relating to this settlement which forms part of this ruling. Under the Agreement: ● You agreed to transfer to your former partner all your right, title and interest in Property B; ● Your former partner agreed to transfer to you all his right, title and interest in the Property A; and ● You and your former partner agreed to split in half the combined outstanding mortgage over the said properties. In order to pay your share of the outstanding debts, you drew a loan.

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

Reasons for decision: Summary: The interest payments you make on the loans you have taken out are only deductible to the extent they relate to an amount which is equal to half of the outstanding Property A debt. | Detailed Reasoning - Detailed reasoning: Under the provisions of 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, you have been ordered by the Family Court of Australia to pay half of the outstanding mortgages on properties you own as joint tenants with your former partner. In compliance, you took out a loan to pay for your share of the debts. The loan amount was employed for or put to use for a number of purposes. Accordingly, it is necessary to apportion the interest payments incurred. | Detailed Reasoning - Property A: The first purpose of the loan was for you to acquire your former partner’s half share in Property A which was a rental property. The proportion of interest incurred on the loan for the purchase of the said property is deductible because the outgoing was incidental and relevant to the purchase of a property from which income is to be derived ( Munro’s Case ). The interest attributable to the loan to buy half of your former partner’s share in the said property, which was used as a rental property, is an allowable income tax deduction under section 8-1 of the ITAA 1997. | Detailed Reasoning - Property B: The second purpose of the loan was for you to satisfy your obligation under the Consent Orders. You agreed to do all necessary acts to transfer your rights, title and interest on the said property to your former partner. The loan is considered to be private or domestic in nature. The money was applied to benefit your former partner, a non-income producing purpose. You have also transferred your legal interest in that property leaving you no entitlement to claim for the interest deductions against its future earnings. Therefore, the interest attributable to the loan to pay off the outstanding mortgage and to transfer your legal right on the said property is not an allowable income tax deduction under section 8-1 of the ITAA 1997.