Private ruling: Rental Property Deductions
Published: August 2012
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: 01 July 2010

Ruling: Q1: Are you entitled to a deduction for the entire interest incurred on your line of credit? | A1: No | Q2: Are you only entitled to a deduction for the interest incurred, on the portion of the line of credit referable to your property, when it was rented or available for rent? | A2: Yes

Relevant facts and circumstances: You purchased a property which became your primary residence. You refinanced the property. The new loan was split into an investment line of credit and a personal line of credit. The personal line of credit was associated with the property. All of your income was paid into the personal line of credit and all of your living expenses were drawn out of the same account. You moved out of the property and rented it out. During this time all of your income continued to go into the personal line of credit and all of your living expenses were still being drawn out of the same account. You purchased another private residence and at this time became aware that a separate line of credit should have been established for the original property. A third line of credit, with the same outstanding balance, was established for the original 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. 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. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. Interest incurred on a loan relating to a rental property will generally be deductible. Taxation Ruling TR 2000/2 examines the treatment and consequences of payments to lines of credit in excess of the required amount and the subsequent redrawing or withdrawal of these funds. It is considered that a repayment to a line of credit in excess of the required amount is a permanent reduction to this debt. The extra repayments do not create a debt due by the lender to the borrower, but simply allows the borrower to then draw funds from the line of credit to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant. Accordingly, redraws may then result in circumstances where a loan contains mixed purposes. In these instances you are entitled to a deduction for the portion of the interest of the line of credit which relates to an income producing purpose. | Detailed Reasoning - Apportionment calculations: TR 2000/2 provides that where a taxpayer has a mixed purpose account, the interest needs to be apportioned between the income producing and non-income producing purposes. Paragraph 19 to 21 of this ruling provides that where interest on borrowed money accrues daily, we accept that it would be unnecessarily onerous to require a manual daily apportionment calculation. We accept that the interest accrued in a month is deductible where it is calculated using an apportionment approach based on the average outstanding principal used that month for income producing purposes. The deductible portion of interest accruing in each month is calculated as follows: | Detailed Reasoning - total interest accrued for the month x deductible interest percentage figure: The deductible interest percentage figure is calculated as follows: ((A + B) / (C + D)) x 100 | Detailed Reasoning - where: A = opening balance (beginning of month) of outstanding principal used for income producing purposes; B = closing balance (end of month) of outstanding principal used for income producing purposes; C = opening balance of total outstanding principal; D = closing balance of total outstanding principal; Note: the closing balance for one month is the opening balance for the next month. Where a taxpayer makes repayments over and above the required minimum payment and the line of credit facility comprises one mixed purpose sub-account only, the taxpayer cannot choose to notionally allocate the repayments to a particular portion of the total debt, e.g. the non-income producing portion. | Detailed Reasoning - Apportionment example: Barry has a line of credit with the XYZ Bank. His credit limit is $100,000 and when that facility is established on 1 April he draws down $80,000 to invest in income producing shares. Barry's net salary of $4,000 per month is paid directly into the line of credit account on the last day of the month and interest and charges are debited on the same day. Barry redraws $2,000 per month on the first day of the month for living expenses. On 30 April, Barry makes a lump sum repayment of $20,000 from the proceeds of the sale of a private yacht, in addition to the $4,000 repayment from his salary. On 1 June, Barry draws down a further $20,000 for home renovations, in addition to the $2,000 draw down for living expenses. | Detailed Reasoning - Barry's transactions are summarised below:: Date Borrowings and Interest Payments Account Balance Income Portion Non-income Portion 1 Apr 80,000 80,000 80,000 NIL 30 Apr 400 24,000 56,400 56,400 NIL 1 May 2,000 58,400 56,400 2,000 31 May 292 4,000 54,692 52,819 1,873 1 Jun 22,000 76,692 52,819 23,873 30 Jun 383 4,000 73,075 50,328 22,747 The repayments of $20,000 and $4,000 made on 30 April first pay the accrued interest of $400 and then reduce the outstanding principal used at that time for income producing purposes to $56,400. The interest of $400 accrued in April is wholly attributable to borrowed funds used for income producing purposes and is therefore fully deductible. The $4,000 repayment on 31 May first pays the accrued interest of $292 and then proportionately reduces the outstanding principal used at that time for income producing purposes and for non-income producing purposes. The proportionate reduction in the outstanding principal attributable to income producing purposes will be $3,708 x 56,400/58,400 = $3,581, giving a balance of the outstanding principal used for income producing purposes at that time of $52,819. The proportionate reduction of principal attributed to non-income producing purposes will be $3,708 x 2,000/58,400 = $127. The balance of the outstanding principal used for non-income producing purposes at that time, therefore, will be reduced by $127 to $1,873. The interest of $292 accrued in May is related partly to the outstanding principal used that month for income producing purposes and partly to the outstanding principal used that month for non-income producing purposes. The amount of interest Barry can claim as a deduction for May is calculated as: 292 x deductible interest percentage = 292 x ((56,400 + 52,819)/(56,400 + 54,692)) = 292 x 98.3% = 287 | Detailed Reasoning - Barry can claim a deduction of $287 for interest for the month of May.: The borrowings on 1 June of $20,000 for home renovations and $2,000 for living expenses were for non-income producing purposes. The outstanding principal used for non-income producing purposes at 1 June will, therefore, be $1,873 + $22,000 = $23,873. The $4,000 repayment on 30 June first pays the interest accrued that month of $383 and then proportionately reduces the outstanding principal used at that time for income producing purposes and for non-income producing purposes. The proportionate reduction in the outstanding principal used at that time for income producing purposes will be $3,617 x 52,819/76,692 = $2,491, giving a balance of the outstanding principal used at 30 June for income producing purposes of $50,328. The balance of the outstanding principal used for non-income producing purposes at 30 June will, therefore, be reduced by $1,126 to $22,747. The interest of $383 accrued in June is related partly to the outstanding principal used that month for income producing purposes and partly to the outstanding principal used that month for non-income producing purposes. The amount of interest Barry can claim as a deduction for June is calculated as: 383 x deductible interest percentage = 383 x ((52,819 + 50,328)/(54,692 + 73,075)) = 383 x 80.7% = 309 | Detailed Reasoning - Barry can claim a deduction of $309 for interest for the month of June.: Whilst the above method of calculation is not the only one available, it is accepted as a fair and reasonable approach to apportion interest expenses between the income producing and non-income producing purposes. | Detailed Reasoning - Application to your circumstances: In your situation, the deposits of salary and wages to your line of credit are considered permanent reductions or repayments to the loan. The subsequent withdrawals of amounts for your private living expenses are considered to be private in nature. Consequently the interest with respect to your living expense portion of the line of credit is not deductible as it is also considered to be private in nature. Accordingly, you are not entitled to a deduction for the entire interest incurred on your line of credit. However you are entitled to a deduction for the interest incurred on the portion of the line of credit referable to your property, when it was rented or available for rent, under section 8-1 of the ITAA 1997.

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