Tax Tip 130: Tax Deductibility of Breaking a Fixed loan on Owner Occupied

Tax Deductibility of Breaking a Fixed loan on Owner Occupied Property with the Purpose of Buying an Investment Property

Borrowing costs are deductible over a 5 year period or over the life of the loan if shorter. This means breaking a loan and incurring break costs can be deductible in full in the year the loan is broker if the loan relates to an investment property.
See some issues I have written about here:
Tax Tip 29: Timing the breaking of fixed loans


But, Toby raised an interesting question on this thread:
Qantas Credit Union

If someone has an owner occupied loan, relating to the purchase of the owner occupied house, with bank A and this loan is fixed will the break fee be deductible if this loan is broken so that the loan can be moved to another bank B with the purpose of borrowing more to buy an investment property?


The answer I think is "No".
This is because the loan relates to the purchase of the owner occupied property and breaking this loan would, therefore, be a private expense.


What if the original bank refused to lend anymore and the new bank would and the borrower, therefore, had to refinance to get the investment loan? Bank A may have stricter serviceability than Bank B for example.


This doesn’t change the situation in my opinion. The purpose would still be to break an owner occupied loan.

 

I would concur. Private (and preliminary to any deductible purpose)

 

Are you conflating borrowing costs (s.25-25) with both break costs (possibly s.8-1) and mortgage discharge costs (s.25-30) ?

 

hi Rob

you are right this wouldn't be a borrowing cost as it doesn't relate to borrowing expenses but paying it back.

Does it relate to the discharge of mortgage? Or is it penalty interest?

TR 93/7 suggests it might be deductible in relation to mortgage discharge costs if it relates to paying out the loan because of a discharge of mortgage. But where the fixed loan is broken and the mortgage not discharged it doesn't relate to the discharge of mortgage so it would be deductible due to s8-1 (example 1).

This shouldn't change the overall tax deductions though.

TR 93/7
https://www.ato.gov.au/law/view/document?DocID=TXR/TR937/NAT/ATO/00001

 

TR 93/7 makes the distinction between mortgage discharge expenses and the "economic cost" of terminating the loan being the "penalty interest".

The "penalty interest" is treated as merely an extra interest expense which may be deductible under s.8-1 if the original loan interest is deductible.

I would caution that this ruling in in respect of an ongoing rental arrangement. If the break related to selling the property then it might be regarded as a capital expense. This is unlikely to be treated a mortgage discharge cost and would be capitalised into the property cost base.

For the OP relating to vacating an owner occupied dwelling, there is no tax deduction for the break fees or mortgage discharge or any residual s.25-25 loan establishment costs.

There remains the fee relating to establishing the new loan for which there may be a deduction over 5 years under s.25-25.

 

This TR 93/7 has been replaced with
TR 2019/2
Income tax: whether penalty interest is deductible
https://www.ato.gov.au/law/view/pdf/pbr/tr2019-002.pdf