As an expert tax accountant, I often get asked what loan interest tax deductions can be claimed. In some cases, clients assume that all interest on investment loans and the utilization of their redraw facilities is tax deductible. This is not necessarily the case. The ATO has clear rules on what deductions are allowed and this article will cover the basic scenarios that we generally encounter. Helping you to optimise your tax deductions and avoid penalties.
Claiming loan interest expenses
You can claim a deduction for interest expenses incurred on loans that are used to produce assessable income. Examples of such loans are:
Loans to buy investment properties (rental properties)
Loans to buy shares or other income-producing investments. (Note that it's important that investments meet the income-producing investments definition, to do so, a dividend or some other distribution must be paid otherwise the interest will accrue as a capital expense).
Business loans that are used for business purposes
And here’s the important bit. You can claim all the interest expenses as a deduction if the whole loan amount is used to produce income. However, should you use part of any of these loans for private purposes, like going on holiday, you will only be able to claim the portion of the interest expense that was used to produce income.
Example 1
Chris takes out a $350,000 business equipment loan for his roofing business. He uses the whole loan to purchase scaffolding and tools for an upcoming job. Chris can claim a tax deduction for all the interest expenses on this business loan.
Example 2
Melissa takes out a $730,000 loan to purchase an investment property. She uses $690,000 to purchase a small apartment and rents it out. (It's important that the apartment be available to rent at all times in order to meet the income-producing investments definition). Then she uses the remaining $40,000 of the loan to buy a car for personal use. In this case, Melissa may only claim the interest expense on the $690,000 portion of the loan, as this is the only part of the loan that is being used to generate income.
Claiming loan interest on redraw facilities
Many loans offer redraw facilities, allowing borrowers to make extra repayments and still access this money in future (subject to the conditions of the loan). Making additional repayments also reduces the interest expenses on the loan. If the entire redrawn amount is used for business or income-producing purposes, all the interest expenses can be claimed. However, if any portion of the redrawn amount is used for personal expenses the interest on this portion cannot be claimed as a tax deduction.
Example 3
Adam takes out a $500,000 loan for an investment property that he rents out. Over the course of the financial year he pays off an additional $50,000 on the loan. He finds himself in a tight spot urgently needing $20,000 to repair the leaks in the roof of his own home. He redraws this $20,000 out of his investment property loan. Because this $20,000 is used for personal purposes it’s not deductible. Only the interest expenses on the $480,000 portion of the investment property loan is deductible.
Loan interest tax deductions for refinanced loans
You may look to refinancing to secure lower interest rates, to access additional equity or to reduce your monthly loan repayments. When entering refinancing arrangements, we advise our clients to keep clear records of the purpose of the new loan and the interest charges. Interest expenses can be claimed for refinanced loans used to produce income. Should any portion of the refinanced loan be used for personal expenses, interest in relation to this portion of the loan cannot be claimed.
Example 4
Jessica refinances her $420,000 business loan to $500,00 and uses the additional $80,000 to purchase shares in another company. Because the additional $80,000 has also been used for income-producing purposes, Jessica can claim the interest expenses on the entire $500,000 loan (as long as these shares pay a dividend or some other form of distribution).
Example 5
Dave refinances his $1,000,000 construction business loan and uses $70,000 to buy a new trailer. The trailer is used to store and transport Dave’s off-road motorbikes. The trailer is not being used to produce income and is clearly a personal expense. Therefore, he may only claim the interest expenses on the $930,000 portion of the loan.
What if I get my loan interest tax deduction wrong?
The Australian Taxation Office (ATO) can impose penalties for incorrect interest claims. These can be fines for failing to take reasonable care, making false or misleading statements, or recklessly disregarding tax laws. Or they may charge interest on underpaid taxes. To avoid penalties, always keep accurate records of interest charges and how you use your loans.
Talk to our expert tax accountants
It’s always best to consult with your accountant before you take out a loan or use the funds. The team ABA Advice Beyond Accounting is up to date on the latest tax laws and can advise you on an effective overall tax strategy, including optimising your tax claims in relation to loan interest.
Once you use the funds, we can calculate the interest expenses that you can claim on your loans to ensure you avoid penalties. This service is included in our Guide and Grow and Proactive Partner Service Plans, or if you aren’t on one of these plans, contact us and we can put together a proposal to provide you with a comprehensive strategy to optimise your business and personal tax.