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Interest Deductions on Rental Properties and Lines of Credit

Discussion in 'Articles' started by NickM, 14th Aug, 2005.

  1. NickM

    NickM Co-founder Staff Member

    20th Jun, 2005


    Case Study

    The following case study illustrates the importance of separating your investment loans from your private funds.

    Strategy employed by the unwary: Deposit all of your salary into a line of credit (LOC) style loan to save interest.

    Result: Some of the interest on the Investment property loan may be disallowed based on private draw downs.

    Last edited by a moderator: 17th Oct, 2009
  2. NickM

    NickM Co-founder Staff Member

    20th Jun, 2005
    Case Study: Domjan v FCoT

    Case Study: Domjan v Federal Commissioner of Taxation

    The Administrative Appeals Tribunal (AAT) has held that not all of the loan interest incurred by a taxpayer on a joint facility used to finance three rental properties was deductible. In particular, the portion of the interest relating to funds drawn down from the loan facility and used for private purposes was not deductible.

    Interest on drawdown funds

    There was no argument between the parties that the initial funds borrowed from the loan facility were solely attributable to the three rental properties. The taxpayer and her husband made regular payments toward the loan account.

    However, the taxpayer and her husband made private deposits, consisting of a gift from the taxpayer's mother and the husband's retrenchment payout, and also made 10 "private" draw downs from the loan facility.
    The taxpayer argued that in redrawing the funds, she was merely accessing her own private funds. However, the Commissioner considered that the amounts redrawn constituted a new borrowing in accordance with Taxation Ruling TR 2000/2.

    The AAT found the loan documents supported the Commissioner's view that the amounts available to the taxpayer to be redrawn did not stand as a credit in the loan account and that redraws amounted to new advances. Accordingly, apart from where the Commissioner had already conceded that parts of the draw downs were used for income producing purposes, the interest on the draw downs was not deductible.


    In relation to particular draw downs, the taxpayer argued that she had subsequently replenished the loan account with replacement funds so that the deductibility of the interest was maintained.

    The AAT held that the replaced funds were not recoupments because the drawn down funds had not been used to acquire assets, and on sale, some part of the funds had been recovered.

    The AAT upheld the Commissioner's view that where repayments of principal are made to a mixed purpose loan account, the payment is applied proportionately to reduce the balance of the outstanding principal attributable to the income producing and non- income producing use.

    Beneficial interest

    The taxpayer also argued that on deposit of her husband's retrenchment payout to the loan account; she was the sole beneficial holder of the account and, therefore, entitled to the whole of the interest accruing under the account.

    The AAT held that the account was a joint one, and that the receipt of income jointly by the taxpayer and her husband constituted a partnership for income tax purposes. Accordingly, she was only entitled to a deduction for half of the interest.

    Building insurance

    When the taxpayer and her husband obtained the bank loan to finance the acquisition of the rental properties, they were required to obtain building insurance on their family home, which was used as security for the loan. In those circumstances, the taxpayer sought to obtain a deduction for the home building insurance.

    However, the AAT agreed with the Commissioner that the expense was either a private expense or an amount to secure a capital sum and, therefore, not deductible.

    Shortfall penalties

    The Commissioner had imposed a penalty on the taxpayer on the basis that she had been reckless in her expense claims. But, the AAT found that her failure to obtain a private ruling and to seek expert advice in relation to the redraw facility amounted to a failure to take reasonable care, resulting in a 25% penalty.


    If you are depositing your salary and wage income directly into a Loan or Line of Credit that is used predominantly for investment purposes you should seek immediate advice in light of the above decision.

    See also