Private ruling: interest deductions
Published: January 2014
Ruling period: Year ending 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Can you claim a deduction for interest incurred on a loan used to purchase your new private residence? | A1: No.

Relevant facts and circumstances: You currently have an investment property loan secured by your main residence. You are claiming a deduction for the interest incurred on the investment loan. You have now sold your main residence and are in the process of purchasing a new main residence. The settlement of your current main residence will occur prior to finalising the purchase of your new main residence is complete and you are required to discharge the mortgage on your investment property with the proceeds of the sale of your main residence. You will have a new borrowing for the purchase of new main residence.

Relevant legislative provisions: Income Tax Assessment Act 1997 - 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. Taxation Ruling TR 95/25 considers the deductibility of interest. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criteria. Where borrowed funds are used to acquire an income producing asset (for example, a rental property), the interest on the borrowed moneys is considered to be incurred in gaining or producing assessable income. Alternatively, where borrowed funds are used for a private or domestic purpose, the interest on the borrowed funds will not be an allowable deduction. In your case, your lender required you to use some of the funds received from the sale of your main residence to discharge the mortgage on your investment property. Once the loan has been discharged, an interest deduction is no longer available in relation to that loan. The funds borrowed to purchase your new main residence will be used for a private purpose and, as such, the interest on the borrowed funds will not be an allowable deduction. It is acknowledged that had you not been required to repay the investment loan out of the sale proceeds of your current main residence, these funds could have been used to purchase your new home. However, the Commissioner does not have any discretion to allow you a deduction for the interest incurred on your new private residence. As your new borrowing will be used for a non-income producing purpose, a deduction for the interest incurred is not an allowable deduction under section 8-1 of the ITAA 1997.