Private ruling: Rental property - interest expense
Date of advice: 18 January 2024
Published: 26 February 2024
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: X July 20XX

Ruling: Q1: Can you claim a deduction for interest expenses incurred on the loan transferred from your main residence to your rental property under section 8-1 of the Income Tax Assessment Act 1997 ? | A1: No.

Relevant facts and circumstances: You purchased your spouse's share of the property A under divorce settlement and claimed this property as your main residence. Property A was subsequently discharged from the loan. At a later date, you purchased property B and immediately claimed as main residence. About a month after purchasing property B, you rented out property A to produce assessable income. Shortly after you obtained a loan to purchase property B. Sometime later you discharged the mortgage on property B and transferred the loan to property A by another lender.

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. 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 on the deductibility of interest expenses following the Full Federal Court decision in FC of T v. Roberts; FC of T v. Smith 92 ATC 4380; (1992) 23 ATR 494 (Roberts and Smith). Paragraph 3 of TR 95/25 sets out the general principles relevant to the question of whether interest is deductible under section 8-1 of the ITAA 1997: • There must be a sufficient connection between the interest expense and the activities which produce assessable income. The test is one of characterisation, and the essential character of the expenses is a question of fact to be determined by reference to all the circumstances. • The character of interest on money borrowed is generally ascertained by reference to the objective circumstances of the use to which the borrowed funds are put by the borrower (the use test). • Regard must also be had to all the circumstances, including the objective purpose of the borrowing and the nature of the transaction or series of transactions of which the borrowing of funds is an element. In some cases, the taxpayer's subjective purpose, intention or motive may be relevant (the 'purpose' test). Paragraph 6 of Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities states: The deductibility of interest is typically determined through an examination of the purpose of the borrowing and the use to which the borrowed funds are put (Fletcher & Ors v. FC of T91 ATC 4950; (1991) 22 ATR 613, FC of T v. Energy Resources of Australia Limited 96 ATC 4536; (1996) 33 ATR 52, and Steele v. FC of T99 ATC 4242; (1999) 41 ATR 139 (Steele)). Accordingly, it follows that if a loan is used for investment purposes from which income is to be derived, the interest incurred on the loan will be deductible. However, where a loan relates to private purposes, no deduction is allowed. Furthermore, paragraph 42 of TR 95/25 confirms that a new loan where the borrowed funds repay an existing loan is considered to be for the same purpose as the original loan. | Detailed Reasoning - Application to your circumstances: In your case, you drew a loan to purchase property B which has been your main residence since you acquired it. You have subsequently rented out property A. Sometime after obtaining a loan on property B, your main residence, you obtained a new loan to repay the existing loan on your property B using property A as the security asset. The purpose of the original loan to purchase property B as your main residence is for private or personal use as opposed to production of assessable income. Merely transferring the security on the loan does not change the purpose of the loan. Therefore, you are not entitled to a deduction on interest expenses incurred on the loan under section 8-1 of the ITAA 1997.