Property investment: Making tax relief work for you

The basic rule is that interest charges on a loan to buy an investment property are tax deductible. Principal or capital repayments are not tax deductible.

Only the interest component directly related to your property is tax deductible. If you are paying principal and interest on your loan, you will need to work out the interest component each year based on your bank statements.

In addition to interest relating to the property purchase, you can also claim a deduction for interest on loans taken out to:

• Carry out renovations
• Buy depreciating assets (eg furniture)
• Make repairs or carry out maintenance
• Buy land on which a property is to be built

It’s common for financial institutions to offer redraw facilities against existing loans.  Such a redraw may be used for income-producing purposes, non-income producing purposes or a mix of the two.

In this case, the interest on the loan must be worked out between the deductible and non-deductible components, split between the amounts borrowed for the rental property and the amount borrowed for private purposes.

Here’s a tip: avoid mixing loan accounts which have both deductible and non-deductible components.

In the past, so called “split loans” were popular, with a loan was taken out with one component servicing an investment property and another component servicing a private borrowing, like a mortgage on the family home.

This meant it was possible to channel all the cash repayments against the private borrowing (where the interest is not tax deductible) while maintaining a high balance on the investment part of the loan (where the interest is deductible). Such arrangements have been tested in the courts and have been found to be ineffectual.

It is, however, possible to take out separate loans with the same financial institution, with one account for private borrowing and one account for investment borrowing.

This article gives only a basic overview of property investment tax issues.  For more detailed advice and planning, consult an experienced tax professional.