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A lot of investors in Australia have a home loan and most investors use the equity in their home property in order to help them to get enriched with their first investment property or share acquisition. It should be pointed out that some years ago most investment loans were standard long term facilities with an initial interest only period of say 5 -10 years after which they converted to principal and interest. Most properties are negatively geared with investors using their personal income to subsidize the shortfall between interest on their investment loan as well as other costs associated with the property and their investment income.

All those investors with a home loan and a negatively geared investment property should be aware that there is a much more tax effective way to structure their investment loan. You might probably know that until recently there has been considerable confusion amongst property investor tax payers about the deductibility of capitalized interest on an investment loan. The Australian Taxation Office has been promising clarification on this for some time, so, there have been 2 recent developments:

1. A Favourable Private Ruling

It was issued to a taxpayer who had a home loan and an investment line of credit with one lender and an investment loan with another lender. To make it clear, the taxpayer wanted to use as much of his personal income as possible to repay his non-deductible home loan debt as quickly as he could… He did not want to have to subsidize the investment loan by using his salary to pay the shortfall in interest but he wanted to capitalize the shortfall interest on his investment line of credit. In addition, this taxpayer wanted to utilize the investment line of credit to meet any unexpected maintenance costs, rates and the like that attached to the investment property. This allowed him to apply further extra repayments to his home loan. It means that as a result he expected to repay this in full within 10 years (not 30). So, the ATO considered the compounding interest to be deductible and Part IVA was deemed not to apply to deny that deductibility.

2. A Draft Taxation Determination

The main theme of it is whether the deductibility of compound interest determined according to the same principles as the deductibility of other interest. This question was determined by the case “Hart vs. The Commissioner of Taxation 2002” when in the Federal Court considered that there were 2 tests proposed:

1. The use to which borrowed funds are put

2. The purpose of the borrowing

The Commissioner accepts that the principles governing the deductibility of compound interest are the same as those governing the deductibility of ordinary interest.

In conclusion it should be pointed out that any investor with a home loan who wants to buy an investment property must be certain that any investment loan he/she arranges includes a capitalizing investment line of credit.

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