Tax Tip 65: Deductibility of Interest for paying out a loan of a deceased estate

Deductibility of Interest for paying out a loan of a deceased estate

Example
Tom dies and leaves Bob the property at 123 Smith St. Worth $500,000. It has a loan of $250,000. Tom had no other assets.

Bob takes the property with the loan - i.e. the loan must be paid for out of the property. So Bob has 2 choices:

Cause the sale of the property and take the leftover cash, or

Borrow $250,000 and pay out the loan of Tom

If Bob were to rent the property will the interest on the loan be deductible?
Yes probably it will. General rules apply - borrowing to acquire an income producing asset.


Authority
See PBR Authorisation Number: 36396
https://www.ato.gov.au/rba/content/?ffi=/misc/rba/content/36396.htm
(use as a guide, a PBR cannot be relied upon)

 

That's a good one. So Tom could 'live off equity' using his redaw for private expenses for years before his death and then when he dies Bob gets the propery and is able to effectively re-characterises the loan as deductable when he rents the property out, without having to sell the property and purchase another one.

 

Never thought of that either, but you are right!

 

Multi-generational debt recycling

 

Tax Tip 263: Multi-generational Debt Recycling Strategy

 

new link
Legal Database

 

EDITED VERSION OF NOTICE OF PRIVATE RULING

Authorisation Number: 36396

This Ruling is a 'Private Ruling' for the purposes of Part IVAA of the Taxation Administration Act 1953.

YEAR(S) OF INCOME TO WHICH THIS RULING APPLIES:

Year ended 30 June 2003

TAX LAW:

Income Tax Assessment Act 1997 section 8-1.

WHAT THIS RULING IS ABOUT:

Are you entitled to claim a deduction for interest expenses incurred for an income producing property?

THE SUBJECT OF THE RULING:

Your relative passed away and you are a beneficiary the deceased estate.

You were to be bequeathed a property under the terms of the will.

The property was used for income producing purposes and had an existing mortgage at the time they passed away.

The estate had insufficient funds to repay the outstanding mortgage.

You negotiated with the executor of the estate to pay out the remaining mortgage and thus allow the property to be transferred to you, as intended by the will.

You advise that if you had not assumed responsibility for the loan, the property would have been sold by the executor and the proceeds distributed to the beneficiaries.

You have continued to use the property for income producing purposes.

The property is being let at the commercial rate of rent.



COMMENCEMENT OF ARRANGEMENT:

1 July 2002

RULING:

Are you entitled to claim a deduction for interest expenses incurred for an income producing property?

Yes.

EXPLANATION: (This does not form part of the Notice of Private Ruling)

Section 8-1 of Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

Generally interest expenses incurred to acquire a property used for income producing purposes is deductible under section 8-1 of the ITAA 1997, to the extent that it is not capital, private or domestic in nature.

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. TR 95/25 specifies that to determine whether the associated interest expenses are deductible under section 8-1, it is necessary to look at the use to which the borrowings are put.

The 'use' test, established in Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion. Accordingly, it follows that if a loan is used to purchase property from which income is to be derived, the interest incurred will be deductible to the extent that the property is used to produce assessable income.

Furthermore, TR 95/25 at paragraph 42, specifies that interest on a new loan will be deductible if the new loan is used to replay an existing loan which, at the time of the second borrowing, was being used for an income producing activity. (Federal Comissioner of Taxation v. Roberts and Smith (1992) 37 FCR 246; 92 ATC 4380; (1992) 23 ATR 494)

In your case, you obtained a loan to repay the existing mortgage on a rental property owned by your late relative. The purpose of the borrowings was to acquire the rental property which you have continued to use for income producing purposes. It is of no consequence that the property was acquired from a deceased estate as it is the application of the borrowed funds that is the main criterion to determine the deductibility of the interest expenses.

Therefore, consistent with the principles established in TR 95/25, you are entitled to claim a deduction under section 8-1 of the ITAA 1997 for the interest expenses incurred on a loan to acquire the rental property.

 

There may be some complexities and problems if there is more than one estate beneficiary.

 

Also if just one beneficiary