Tax Tip 230: Deductibility of Interest when Refinancing Loans

Back to basis – I don’t think I have written a tax tip on refinancing.

Refinancing one loan with another loan does not change the deductibility of interest..


Example
Homer has a loan with ANZ bank which was used to acquire an investment property. He refinances this with AMP and as the interest was deductible before it is deductible after the refinance.


Authority:
See paragraph 47 in
Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997


Which states:

Borrowing used to repay an existing loan

42. Interest on a new loan will be deductible if the new loan is used to repay an existing loan which, at the time of the second borrowing, was being used in an assessable income producing activity or used in a business activity which is directed to the production of assessable income (Roberts and Smith ATC at 4388; ATR at 504).

 

interest on a new loan used to repay an existing loan will generally also be deductible as the character of the new loan is derived from the original borrowing (Taxation Ruling TR 2000/2).

 

However when refinancing take care about increased borrowing limits as that can create a blended loan.

eg Mary has a NAB loan (used to acquire her Dubbo investment property) of $389,445. She refinances to Liberty for $400K and the new loan discharges the old NAB loan and also leaves $10,555 which she may put towards a new car etc. The new loan is now blended. Even if the increased borrowing was for a deductible purpose eg pay for repairs to her Melbourne investmnet apartment the loan is still blended as it relects two different properties in the proportions 97.36% Dubbo and 2.64% Melbourne.

 

Sorry to revive an old thread, but if the surplus funds are settled to an account with no other money, can Mary pay the surplus back into the loan and retain the 100% purpose? Or would this still be a mixed purpose loan?

 

Technically the loan is mixed and repaying it back in will dilute both portions. But where the offset contains no other money except the borrowed the borrower can argue it is not mixed and therefore putting the money back in the should should pose no problem.

The problem is there is no ATO guidance on this. Just some vague private rulings which don't specifically cover this topic. but touch on it.

see my tax tip 1.

 

Is the process difficult to get a private ruling regarding these matters?

My loan is due to settle any day now and I'm expecting the bank to mess it up, I've provided directions for settlements on the loan splits etc but it seems unlikely they'll get it correct given their own forms don't even allow for this.

 

If you were a client i would do it for free as a test case.

It is not difficult to do though and they allow some flexibility for lay persons submitting - i.e. not as strict as they would be with a tax agent or lawyer on the prep.

But if you ask the wrong question you will get the wrong answer.

 

1. Ensure each loan has redraw AND confirm this with lender.
2. Credit any advance on the establishment back to the loan
3. Then you redraw as needed and you manage it.

Lenders typically will "advance" the loan on day 1 as thats what the loan documentation and legal elements for the mortgage requires.

 

many if not most lenders will not credit the advance back in the loan.

If it is NAB they will deliberately put the advance in the wrong offset account. If might be worth emptying offset accounts before settlement to preempt anything like this.