May 2009

Please advise what options we have to get interest deductible from our income.

Our panel of experts answers property investment questions from API readers. For more Q&As, see this month’s API magazine.

Costly mistake

We refinanced our house (Property A) to buy an investment (Property B) in 2007. In 2008, we bought Property C with a separate mortgage. We moved into Property C while we prepared Property A for sale. In mid 2008 we sold Property A and paid off Property B (silly us). Now we have a situation of paying interest for Property C (loan balance is $200,000) but we can’t claim tax deductions on it because we live there. Meanwhile, we’re collecting rent from Property B but there’s no interest against it to claim. We have liquid cash of $150,000. Please advise what options we have to get interest deductible from our income. Do we buy another investment property? Or can we refinance our loan?

A First up, use the $150,000 to reduce your loan balance to $50,000. If you think Property C will one day become a rental property then instead of paying the loan down put the $150,000 into an offset account linked to the loan for Property C. With the rent coming in from Property B I would hope you could very quickly reduce this $50,000 to zero but if your circumstances are such that it will take several years then it may be worth considering other alternatives such as capitalising the interest on another investment property and using the rent on it to reduce the $50,000. Warning – do not do this without a private ruling from the Australian Tax Office. You refer to ‘we’ in describing the owners of the property so I assume your spouse owns half. One of you could consider selling their half of Property B to the other, who borrows the money to buy their spouse out so it would be deductible (Interpretative Decision 2001/79, but again get your own private ruling). The selling spouse could then use this money to pay off the $50,000 loan. You can’t just refinance the loan to make it deductible. If you do buy another investment property make sure you borrow the whole of the purchase price and costs but other than capitalising interest this won’t help you much. Julia Hartman

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