Tax Tip 87: Moving out of the Main Residence and Interest

When a person moves out of their main residence and rents it out any interest on the loan used to acquire that residence should be deductible.

Some confuse the 'purpose test' with this by thinking the the purpose of the loan was private - it was used to buy a main residence and therefore the interest won't be deductible. But the purpose of the loan was actually to buy the property. Deductibility is determined by the use the money was put to. It was used to buy the property and therefore any interest on the loan remaining, which is associated with the purchase, should be deductible.

But people get into trouble by paying down and redrawing again.

Example 1
Mr X buys 123 Smith Street for $500,000. He borrows $400,000 PI. after 5 years the loan is now $300,000. Mr X then moves out and rents the property out. He can claim the interest on $300,000.

Example 2
Mr X buys 123 Smith Street for $500,000. He borrows $400,000 PI. after 5 years the loan is now $300,000, but this is a LOC loan set up by a broker that charged him $4000. Over the years money in the form of salary and gifts, lotto winnings etc has been deposited and living expenses taken out weekly.

In this example he has a severely mixed loan and the amount associated with the purchase of the property could be nil or very low - yet he has a large amount outstanding. No or low interest may be deductible.

Example 3
Mr X buys 123 Smith Street for $500,000. He borrows $400,000 PI. after 5 years the loan is now $200,000 but there is $100,000 available in redraw. Mr X withdraws $100,000 thinking this will enable him to claim interest on $300,000. But it won't because the $100,000 is consider new borrowings and the deductibility on this will depend on what it is used for.

Mr X can claim interest on $200,000 once the property is rented out.

Example 4
Mr X has a neighbour named Mr Y. Mr Y buys 125 Smith Street for $500,000. He borrows $400,000 IO with an offset account. after 5 years the loan is still $400,000. Mr Y could claim the interest on $400,000 if he were to move out and rent the property.

 

Is there any way to split the loan, pay out a portion, use that portion for redraw and use on an IP, then , later re merging somehow to make up the original borrowing, I think I know the answer, but maybe brighter minds have thought of a way that would comply

 

There is another way. Stay tuned for my next tax tip tonight.

 

Actually the loan would be mixed in this case. So more accurate to say 2/3 of the interest could be deductible against the rent on Smith Street. $300k loan with $200k relating to the purchase of Smith Street and $100k relating to something else.
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It would be in my X's best interest to split the loan