Tax Tip 323: Is it Use or Purpose of Loan that Counts for Deductibility of Interest?

Discussion in 'Accounting & Tax' started by Terry_w, 4th Jan, 2021.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    It is generally ‘use’ to which the borrowed funds are put that determines deductibility of interest on a loan.

    Some say it is the ‘purpose’ of the loan that counts, but this can confuse people in situations where they borrow to buy a main residence – the purpose is a private expense. But they later change their mind and rent the property out, the purpose of the loan doesn’t change.



    But when you think of as the ‘use’ the money was used to buy the main residence. Later the taxpayer moves out and rents the property. The use of the loan still remains the same – it was used to buy the main residence and once that residence is income producing the interest becomes deductible.



    However, I guess you could also look at this as ‘purpose’. The purpose of the loan was to buy the main residence – with the use later changing, making any loan interest that was used for the purpose of acquiring the main residence being deductible.



    Example

    Homer borrows $400,000 from ANZ bank to buy his main residence. He pays it down to $300,000 and then redraws $100,000 to buy a boat.

    Later he moves out and rents the property.

    The purpose of the loan was to acquire a main residence.

    The use of the borrowed funds was initially to buy a main residence, but there is an additional use of the $100,000 to buy a boat.

    So it is a mixed use loan, and the interest on it would only partially be deductible once the property was rented out.
     
    Peerdon, Pingu1988 and craigc like this.
  2. Peerdon

    Peerdon Member

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    Great advice!

    Just wanted to see what your thoughts are on my current situation. My wife and I are currently living in our main residence and have drawn equity on it in the form of 2 x $125k loans ($250k total). Loan 1 has not been drawn on, the other, Loan 2, I have used $25k (of the $125k) for my business to purchase stock.

    I am now looking to purchase an investment property. Can I use Loan 1, the undrawn $125k AND the remainder of Loan 2, $100k, to combine into the investment property? Would the $100k from Loan 2 still be tax deductable as the initial $25k was used for investment/business purposes as well?

    In addition, we may be contributing $200k cash into this investment property too as currently we're not in a position to take out more loans therefore the investment property won't be as geared as I'd like it to be.

    Cheers!
     
  3. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Sounds like you should be getting some tax advice as you will be able to save same tax if you do it right
     
    craigc likes this.