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ktm380(Initiate)Initiate
10 Feb 2025

Hi,

I currently have two properties which are worth more than the money owing. I am looking at re-financing these loans and increasing the borrowed amount with the intention of using the borrowed money to repay the loan. This is primarily to help with personal cash flow for a few years.


One of the properties is currently rented 100%, and the plan is to continue this. The second property is planned to be rented, but currently is not.


In both cases, the "purpose" of the loan is to use these additional funds to pay the interest on a income producing asset. This money would sit in a dedicated offset account and only be used for this purpose. In the case of the house which currently is not rented, the funds would not be used during times of no income. This approach would primarily be an attempt to ensure the loan isn't what I would consider diluted (mixture of asset producing and personal purpose).


In this case, what interest can be claimed? i.e can the interest on the refinanced portion of the loan be claimed as well as the interest on the originally borrowed amount? In this case, the borrowed money (which is in the dedicated offset account) would slowly be consumed. Would the refinanced amount be then considered 100% for that property (not apportioned)?


If not, how would the ATO see these loans in terms of deductions etc?


Thanks.



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Matt1207(Initiate)Initiate
10 Feb 2025

The tax deductibility of interest on your refinanced loan depends on the purpose of the borrowed funds, rather than the property used as security. The interest on the original loan for the fully rented property should remain deductible, while for the second property, deductions would only apply once it is rented out and generating income. If the additional borrowed funds are strictly used to cover the interest on the rental properties, the ATO may allow deductions, but borrowing to pay interest (capitalising interest) can be scrutinised, especially if it results in a personal cash flow benefit rather than directly generating rental income. Since the additional borrowed funds will sit in an offset account, the ATO may assess whether they are genuinely for income-producing purposes, and deductions may only apply once funds are actively used for rental expenses. To ensure full deductibility, you should maintain clear records linking all withdrawals to rental-related costs, as the ATO may otherwise apportion or deny part of the deduction. Consulting a tax professional is advisable to ensure compliance with ATO guidelines.

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Most helpful reply

Matt1207(Initiate)Initiate
10 Feb 2025

The tax deductibility of interest on your refinanced loan depends on the purpose of the borrowed funds, rather than the property used as security. The interest on the original loan for the fully rented property should remain deductible, while for the second property, deductions would only apply once it is rented out and generating income. If the additional borrowed funds are strictly used to cover the interest on the rental properties, the ATO may allow deductions, but borrowing to pay interest (capitalising interest) can be scrutinised, especially if it results in a personal cash flow benefit rather than directly generating rental income. Since the additional borrowed funds will sit in an offset account, the ATO may assess whether they are genuinely for income-producing purposes, and deductions may only apply once funds are actively used for rental expenses. To ensure full deductibility, you should maintain clear records linking all withdrawals to rental-related costs, as the ATO may otherwise apportion or deny part of the deduction. Consulting a tax professional is advisable to ensure compliance with ATO guidelines.

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ktm380(Initiate)Initiate
10 Feb 2025

Thanks for the quick reply Matt. Makes sense to me what you are saying. I should have added (and you eluded to) the money in the offset account would not be for personal use as the offset account would be solely linked to the loan account for the individual property. i.e. the deductions would only be claimed once actively used.


It seems it could be a tricky situation. I am sure these thoughts are not new and unique to me. It would be good if you (or others) know of any tax rulings or examples on this situation. I have spent some time, and I haven't been able to find anything.


Thanks again.

Matt1207(Initiate)Initiate
10 Feb 2025

You're welcome! It sounds like you're taking a careful approach to ensure compliance, and you're right that this situation can be a bit tricky. As for tax rulings or examples, the ATO has provided some guidance on interest deductions for borrowed money, particularly in relation to the purpose test (i.e., whether the borrowed money is used for income-producing purposes). However, the specifics of your situation, such as using the borrowed funds in an offset account, aren't commonly outlined in a single public ruling.

In general, the ATO's view on these situations can be found in Taxation Ruling TR 2000/2, which provides general guidance on interest deductibility for loans used to purchase or maintain income-producing properties. It emphasizes that the key to claiming the interest deduction is ensuring that the borrowed funds are used for producing assessable income, such as rental income. The ATO has also stated that capitalising interest (i.e., using borrowed funds to pay interest) can raise concerns if it appears to be a way to generate a personal benefit rather than an income-producing one.

Additionally, Taxation Determination TD 2008/22 discusses interest deductions in scenarios where borrowed money is used for mixed purposes (e.g., both income-producing and personal use). It stresses the need to clearly separate the usage of the loan and maintain documentation showing the portion of the borrowed funds used for rental income.

Since your setup with the offset account seems to be solely linked to the loan for the property, and the funds would only be used for rental expenses, you seem to be on the right track in aligning with the ATO's guidelines. However, the fact that the second property is not yet rented out may complicate matters, as deductions can only be claimed for income-producing purposes once the property is generating income.

Given the complexity, I’d recommend consulting with a tax professional who can assess the specifics of your situation and advise on whether any specific tax rulings or examples would apply to your scenario. They can help you navigate the nuances of mixed-use loans and offset accounts, ensuring you’re in full compliance with the ATO’s guidelines.

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