Private ruling: Rental property expenses
Published: September 2017
Ruling period: Year ended 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021
Date scheme commenced: 1 July 2015

Ruling: Q1: Where an amount is repaid on your investment loan are you entitled to a deduction for the full amount of interest expenses incurred after redraw funds are used for personal purposes? | A1: No.

Relevant facts and circumstances: You own a rental property. The property was purchased using a loan from a financial institution. The property has been available for rent and tenanted since it was purchased. The income and expenses have been included in your relevant income tax returns. You sold your main residence, and transferred the proceeds from the sale to the investment loan, as advised by a financial planner. You have made multiple redraws from your investment loan, to fund the building of your new main residence. It was only after you had spoken with your registered tax agent that you became aware of the tax consequences of making the lump sum payment to your investment loan. You now believe that you were provided with incorrect advice.

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 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 Income tax: deductibility of interest on moneys drawn down under a line of credit facilities and redraw facilities, examines the treatment and consequences of payments to loans in excess of the required amount and the subsequent redrawing of these funds. It is considered that a repayment to a loan account in excess of the required amount is a permanent reduction to this debt. Repayments of an amount to a loan do not create a debt due to the borrower, but simply allows the borrower to then draw funds from the loan to an agreed limit. These redrawn funds therefore constitute new lending and as such, the purpose or use of these drawings is relevant. 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 loan which relates to an income producing purpose only. Paragraphs 19-20 of TR 2000/2 contain formulas which can be used to calculate the income producing portion of interest. In your situation, after obtaining financial advice, you chose to apply the proceeds from the sale of a property to your investment loan with the intention of redrawing the funds at a later date to fund the building of your new main residence. Whilst the application of the funds was done without your full understanding of the taxation consequences, regard must be had to what has actually occurred. The depositing of the sale proceeds is considered a permanent reduction to the loan. The nature of the redraws made is characterised by the use to which they have been put and an examination of their application must be made. In this instance, the redrawn funds have been used towards the building of your new main residence, so it is appropriate to characterise these redraws as being for private or personal use. Accordingly, you are not entitled to a deduction for this portion of interest, and the loan is now regarded as a mixed purpose loan.