Private ruling: Rental property interest deductibility
Date of advice: 10 August 2016
Published: September 2016
Ruling period: Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2019
Date scheme commenced: 1 July 2015

Ruling: Q1: Are you entitled to a deduction for interest payable on the portion of the loan which is still referable to the purchase of the property at the time the property became a rental property? | A1: Yes

Relevant facts and circumstances: You purchased a house as your principal place of residence at 50% legal ownership interest. You now rent the house. You purchased the house using joint borrowings. The initial loan had fixed and variable interest components. After a period of time you combined the original loan into a line of credit, with various changes made to the line of credit and loan amounts over time. You used the line of credit for your banking transactions, including payments in and out. By the time you rented the property you had converted the loan back to a fixed loan.

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

Reasons for decision: Summary: Interest deductibility on property originally used as principal place of residence Section 8-1 of the Income Tax Assessment Act 1997 (ITAA97) allows you a deduction for any loss or outgoing that is incurred in gaining or producing your assessable income, to the extent that it is not of a private, capital or domestic nature. 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 (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. Where borrowed funds are used for investment purposes such as the acquisition of a rental property, the interest will be deductible to the extent that the property is used to produce assessable income. In your case you jointly own a property which was originally your primary place of residence and has been converted into an investment property. The interest on this loan is deductible from the time you are earning assessable income from the property, to the extent that, the use of the funds were for investment purposes (discussed further below). You have a 50% ownership and borrowing interest. Therefore, as you are using the property for income-producing purposes, the interest on the loan that relates to the purchase of the property will be deductible at a 50% share. Line of credit - where borrowed money is applied for both income and non-income producing purposes TR 2000/2 Income tax: deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities (TR 2000/2) addresses the deductibility of interest on moneys drawn down under line of credit facilities and redraw facilities. 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. As noted above, where a borrowing is used to acquire an assessable income producing asset, or relates to expenses of an assessable income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income. Where interest accrues periodically on a line of credit facility on the outstanding balance of a mixed purpose line of credit, the deductibility of accrued interest is determined by considering the application of the borrowed funds for income producing and non-income producing purposes. Where a taxpayer has a mixed purpose line of credit account the interest needs to be apportioned between, the income producing and non-income producing purposes. Apportionment must be made on a fair and reasonable basis. TR 2000/2 provides an example of a reasonable basis at paragraphs 19-21. Paragraphs 53-60 provide an example of the use of the apportionment method listed in the ruling. Paragraph 39 of TR 2000/2 discusses the treatment for a loan facility that allows for redraws of extra repayments. We consider the redraws to be new borrowings of funds that cannot be traced to the extra repayments. A draw down on a line of credit that has not been fully drawn is a new borrowing of funds. In your case you have used your line of credit facilities as part of your original loan on the property. Therefore you are entitled to deduction for the portion of interest on the line of credit amount that can be attributed to the original loan amount for the acquisition of the property. | Detailed Reasoning - Ruling restricted to four years: The Commissioner does not generally provide rulings for indefinite periods due to potential changes to the law in the future and also to potential changes to the facts and circumstances of the case. For this reason this ruling has been restricted to the period covered by the four financial years up to the year ended 30 June 2019. However, this does not mean that you are required to apply for a new ruling every four years. In the absence of any change to the legislation, the interpretation of the law as explained in this ruling will continue to apply.