Tax Tip 129: Deductibility of Loans when later renting out your main residence.

Deductibility of Loans when later renting out your main residence

Interest on loans is only deductible if it relates to the production of income. With property this means only those loans used on properties that generate income.


Where you took out a loan to buy a PPOR you may think the purpose of the loan is private. You borrowed to buy the main residence. But you actually borrowed to buy a property and this is the purpose. If this property were to become income producing then any interest on a loan related to its acquisition could then become deductible.


But what sometimes happens is that people put money in and out of the loan thinking that there is no tax to claim so it doesn’t matter. Well, it will matter if the property later becomes income producing because it will be a mixed purpose loan. Some of it will relate to the acquisition of the property and some will relate to private expenses.


Example

Doug buys a house for $500,000 with a $400,000 loan. He pays it down to $350,000 and then uses redraw to buy a car for $50,000.


A year later he moves out.


Doug has a mixed purpose loan. Only $350,000 of it relates to the purchase of the property, and $50,000 relates to the purchase of a car.


Imagine the problem if Doug did this say 100 times, perhaps depositing his salary in the loan and redrawing. He could end up with a large loan balance but with only a small portion relating to the purchase of the property and therefore, only a small percentage of the interest being deductible.


Tip – plan ahead, just in case.

 

And one of the key reasons why a offset on the home protects "savings"from depleting future deductions. eg if $30K of saving weere banked to reduce the loan the deductible might be $320K. If the $30K had been banked to a offset the $350K would be protected.