Private ruling: Rental Interest Expense
Date of advice: 13 November 2015
Published: February 2016
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Is a deposit made to an investment property loan account able to be disregarded in order for additional interest to be deducted? | A1: No.

Relevant facts and circumstances: You had a primary residence. The home loan is in joint names. You purchased another property which was to become your new primary residence. A second loan account was established for this property. On settlement excess funds were deposited in your home loan account in relation to the original property. You confirmed that the funds have remained in the account since they were deposited. You have made your former primary residence available as a rental property.

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 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. 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. When a person moves out of their home and then rents out the property at a commercial rate, the interest on the outstanding loan is generally an allowable deduction. Taxation Ruling TR 2000/2 contains the Commissioner's view on the deductibility of interest with regards to line of credit and redraw facilities. We consider draw-down from a line of credit account or sub account, or a redraw from a loan account, is a separate borrowing. To the extent borrowings are used for income producing purposes, that part of the accrued interest attributable to those borrowings is deductible. Conversely, that part of the accrued interest attributable to borrowings for non-income producing purposes is not deductible. In your situation, the deposit of the excess funds to your loan with a redraw facility is considered a permanent reduction or repayment to the loan. Although you have stated it was not your intention for the amount to be applied to the investment property account, the amount has been applied and reduced the balance owing. This will reduce the amount of interest incurred. The funds have not been transferred to another account or used for any other purpose at this time. Should the money be withdrawn from the account, it will be considered to be a redraw in relation to the loan. At paragraph 22 of Taxation Ruling TR 2000/2 the Commissioner states that the deductibility of interest on a further borrowing of money under a redraw facility depends on the use to which the redrawn funds are put. If this is for a non-income producing purpose then the interest on the redraw amount is not deductible. You are unable to re-establish the excess funds applied to your loan. Paragraph 17 of TR 2000/2 states that where money borrowed and applied to a particular use is recouped, the loan can no longer be regarded as continuing to be applied to that use. Where borrowed funds are repaid and the loan balance reduces, those funds have ceased to be outstanding funds used for any purpose.