Interest Deductibility On Investment Properties

Claiming a taxes deduction on accommodations property is fairly straightforward. The general rule is that any expense you incur on a house available for rent is usually tax-deductible. This is so long as it was for producing local rental income and wasn’t a capital, private or home in nature. Where it has been more complicated is on one of the “big ticket items usually claimed by landlords. The Australian Tax Office’s Tax Determination TD 2012/1 is casting some question on the deductibility of interest on loans used to buy an investment property under certain, not unusual, loan plans.

This is in fact not the very first time the tax office has portrayed concerns over interest deductions. In 2004, the deductibility of interest on a split loan arrangement was considered by the High Court in FCT v Hart within the ATO’s test case program. The situation pertained to a “split loan” or “linked loan”, that was a borrowing service put into sub-accounts.

It was something that a few financial institutions offered at enough time. In an average split-loan arrangement, one of the sub-accounts is a true home loan, the other an investment property loan. Within the facility, the lending company calculates the loan repayments (and interest) on the aggregated loan balances of all sub-accounts.

However, each loan repayment is applied to the sub-account for the house loan first. No repayment is required on the sub-account for the investment loan. The interest expense incurred on the investment loan is capitalized and put into the loan principal. This arrangement has the aftereffect of compounding the tax-deductible interest on the investment loan while also accelerating the repayment of the house loan.

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The High Court sided with the Commissioner of Taxation. If the taxpayers hadn’t joined this agreement, loan payments (including interest) would have to have been paid on both the mortgage loan and investment loan in the standard manner. This would not have given rise to the taxes deduction on the excess interest (incurred on the capitalized interest) and would have avoided principal reductions that were added to the investment loan. Your choice in the Hart case effectively end split loan agreements as a taxes-effective strategy.

Arguably, other loan arrangements that didn’t talk about most of the same elements of split loan preparations weren’t affected. Fastforward to March 7, 2012, when the Commissioner released TD 2012/1 and we’re now viewing a development that appears to have received limited attention at this time. Part IVA … connect with refuse a deduction for some, or all, of the eye expense incurred in respect of the “investment loan interest payment agreement” of the sort explained in this Determination?

The more troubling aspect is, “This Determination applies to years of income commencing both before and after its time of issue”. Quite simply, the Determination retrospectively applies. …if the scheme was not entered into or carried out, the taxpayer(s) would have met the interest payments on the investment loan out of their own cash flow rather than use the credit line. Thus, the taxpayer(s) would not have incurred any interest or would have incurred less interest, at the risk of credit. Where to go from here?