Deductibility of Capitalising interest on an Investment Line of Credit

On April 16th 2008 the ATO issued a favourable Private Ruling to an Austral borrower based on the following facts:

The borrower was entering into loans as follows:

Lender A
Contract 1 being an interest only term home loan account.
Contract 2 being an interest only term investment account for the purchase of an investment property.

Although these loans are interest only borrowers are able to make additional repayments of principal at any time without penalty.

Both loans with Lender A are secured over the home property and are split to avoid any issues regarding mixed-purpose accounts as generally described by the ATO (TR2000/02). The ATO’s Private Ruling is based on a specific loan structure and specific loan documents provided to the ATO with the Private Ruling Application.

Lender B

A single capitalising investment line of credit which would be utilised to

1. meet any balance of purchase price if required for the investment acquisition.
2. meet any unexpected maintenance costs on the investment property
3. meet any shortfall of interest and / or expenses that may result where rental income derived in any financial tax year was not sufficient to cover interest and deductible expenses relating to the investment property.

The line of credit is secured over the investment property. Again, specific loan documentation was provided to the ATO and it is upon this documentation that the Private Ruling issued.

The taxpayer advised the ATO in his application that he wanted to enter into the structure as described because he did not want to use his personal income to subsidise the interest and other costs associated with his investment property. He further advised the ATO that wherever possible he would apply as much of his freed up personal income as possible to the repayment of his non-deductible home loan debt. The ATO issued a Private Ruling wherein it confirmed that in this scenario and on the basis of the loan documents provided:

1. the interest expenses incurred on the investment line of credit were deductible under ITAA 1936 section 51(1) and section 8-1
2. Part IVA of ITAA 1936 would not be applied to deny the deductions for interest on the investment line of credit.

Although this is a Private Ruling only, it nevertheless provides some current indication on how the ATO is thinking and some level of comfort to investors who may also want to avoid using personal income to subsidise investment interest and costs.

The benefits offered by this structure to investors with both a home loan and an investment loan include:

1. It affords some protection to the investor when vacancies occur. The investor can draw on the line of credit to meet interest payments or other costs.
2. If cash flow is tight generally, rather than selling the investment property in an unfavourable market, the investor can hold the property and capitalise any shortfall between rental income and outgoings.
3. If cash flow is not a problem, rather than applying any personal income to the payment of interest on the investment loan or other expenses associated with the investment property, the taxpayer can allow this shortfall to capitalise under the investment line of credit with Lender B, and apply the cash flow benefit towards additional repayments to his home loan. This enables the borrower to repay his home loan much more quickly and enjoy significant savings in interest as a result.

Any borrower - who has a home loan and an investment loan, and is currently subsidising the costs on the investment from personal income - may be interested in restructuring his / her loan to provide a cash flow buffer if required, or to free up personal income for personal use, if preferred.

As a general guide the ATO publishes edited versions of Private Rulings on its website within 28 days of issuing them. As at 26th May the Private Ruling outlined above has not been published.

Should you wish to discuss the above with us please do not hesitate to call Mark Bonaventura or Paul Bonaventura on (02) 9299 1833.