Private ruling: Rental property expenses - interest
Published: March 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 2006

Ruling: Q1: Are you entitled to claim a deduction for interest incurred on a loan used to purchase an income producing property after the cessation of the relative income earning activity? | A1: Yes

Relevant facts and circumstances: You purchased rental properties in conjunction with your sibling. The properties were purchased with the view of producing assessable rental income. The properties were secured by mortgages over the properties themselves and the residence of your parents. Over time losses began to accumulate which could not be recovered by the rental income. The properties were sold which resulted in a capital loss, and the sale proceeds were insufficient to repay the mortgage. The mortgage was refinanced again using your parents' residence as security. The interest on the new loan was claimed as a deduction on the rental properties until a drawdown of the loan equity took place, the funds being used to conduct a business.

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 2004/4 deals with the deductibility of interest when it is incurred prior to or after the cessation of the relevant income earning activity. Paragraphs 10 to 14 of TR 2004/4 state the following in respect of interest incurred after the cessation of the relevant income earning activity: Where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased, it is apparent that the interest is not incurred in gaining or producing the assessable income of that period or any future period. However, the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period. Whether or not the occasion of the outgoing of interest is to be found in what was productive of assessable income of an earlier period requires a judgment about the nexus between the outgoing and the income earning activities. An outgoing of interest in such circumstances will not fail to be deductible merely because: § the loan is not for a fixed term; § the taxpayer has a legal entitlement to repay the principal before maturity, with or without penalty; or § the original loan is refinanced, whether once or more than once. However, if the taxpayer: § keeps the loan on foot for reasons unassociated with the former income earning activities; or § makes a conscious decision to extend the loan in such a way that there is an ongoing commercial advantage to be derived from the extension which is unrelated to the attempts to earn assessable income in connection with which the debt was originally incurred, the nexus between the outgoings of interest and the relevant income earning activities will be broken. A legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities. In your case, the original mortgage was obtained in order to acquire income producing rental properties. Hence the interest on the mortgage is held to be incurred or gaining or producing assessable income, and is hence deductible under section 8-1 of the ITAA 1997. As stated in TR 2004/4, if interest incurred after an income producing activity has ceased can be traced back to the original income earning activity, it will continue to be deductible. This will not change even if the loan is refinanced. As a proportion of the interest on your current loan is being charged on monies used to refinance the mortgage used to purchase your rental properties, this interest will continue to be deductible as it is being incurred in relation to the original income earning activity.

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