Call 07 3421 3456


a borrower, a lender and an adviser sitting around a table to sign loan documents for the purchase of an investment asset - loan interest cost deductible

Interest cost deductibility

Interest cost deductibility saves tax, lessens borrowing costs
gear cogs

Interest cost deductibility is one of the factors considered in making a decision as to whether to gear an investment. Gearing is a popular strategy used by many Australians to improve their wealth. Popular investment assets acquired in a geared portfolio include rental property (residential, commercial, industrial etc), shares and managed funds.

The cost of borrowing for an income producing asset/ portfolio, is significantly less than borrowing for non-income producing acquisitions.  (We wrote about this in our article ‘Bad debt made good’.)

Gearing is a popular cog in the wheels of wealth creation.

Interest paid on loans raised to gear investments for income producing purposes can be offset against the income they generate.  It is important that care be taken in calculating this cost for reporting in your annual income tax return.

To make this process more efficient, care needs to be taken where a single asset secures multiple loans. These cases require the segregation of the loans to facilitate allocating the borrowing costs to unique investments. This is particularly the case where loans for personal use are secured against the same asset.

Segregating the loans achieves the following benefits –

  1. Your interest expense is readily able to be allocated to the investment to which it relates; and
  2. There is less risk that the interest cost deductibility will be challenged by the ATO. (They are alert to loan costs having been ‘blended’ in these cases.).

How will interest cost deductibility be effected?

Loans terms that facilitate redraw are a particular concern in this regard. A redraw facility, allows deposits reducing loans to be redrawn for subsequent needs. This process gives rise to the risk that –

  1. There is a blurring of which part of the loan has been repaid.  This gives rise to the question as to what portion of the interest beyond a redraw is tax deductible; and
  2. A redraw for personal use purposes is of particular interest for the ATO.  They often form a different view from the taxpayer as to what the relevant portions are.  Tried Case Law appears to be on the side of the Commissioner in this situation. These loans are treated as blended loans.

Managing the overall loan cost using a single loan may be financially more efficient and convenient. However, the risk that the interest cost deductibility for tax purposes is diluted, may prove a financially disadvantage.

If you are unable to segment the borrowings into unique accounts, and you are using a redraw facility, it would be better to arrange an interest-offset deposit account to operate alongside the loan account.  This may prove to be a less financially efficient process, but should minimise the risk of the tax deduction being compromised.

Consider the following scenarios:
home securing bank loan segmented into specific uses optimises interest cost deductibility






Scenario 1: A segmented loan scenario –

In the scenario depicted above, as repayments are made they would be allocated to the personal-use asset loans first.  If further funds are subsequently required, they would be drawn against an appropriately designated separate account. This strategy will have no dilution effect on the interest cost deductibility of interest attributable to income-producing purposes.

Using this structure, non-deductible (bad) interest is reduced first.  The deductible interest continues to accrue until the loan funding the personal-use assets is completely repaid.

Importantly, the precise amount of interest attributable to each income producing project is readily identifiable.

home securing a bank loan in one account though used for different purposes may be a challenge to interest cost deductibility

Scenario 2a: A lump-sum loan with redraw facility –

In this scenario the borrowing is drawn into a single loan and the disbursed for both personal-use and for income producing purposes.  Extreme care has to be taken when calculating the interest that is attributable to each project in this situation. This is especially so where committed repayments are being made.  Under the normal terms of such a loan, the lender does not segregate the interest costs against the uses to which you put the borrowed funds.  You are left to deal with the Taxation Office which is likely to apportion repayments according to the initial use proportions for the first year.  They may then revise the proportions annually, adjusting the deductibility to the calculated diminishing balances.

This process becomes more complicated if/ when there is a redraw against any capital repayments that have been made.  This is particularly so where the redraw has been for personal-use purposes.  As detailed above, this has the effect of eroding the interest deduction available against income-produced by the relevant borrowed funds.  The Taxation Office has led argument that none of the interest on such accounts is allowable as a deduction because of the blending of the loan amounts.

Scenario 2b: A lump-sum loan with a linked interest-offset account –
home securing a bank loan with multiple purposes but with an offset account risks reducing interest cost deductibility






This scenario should produce a more acceptable outcome than that achieved through scenario 2. This is particularly so if any drawdown is only made from the Interest Offset account as opposed to paying down the loan.  Redrawing in this way risks the ‘merging’ of the loan amounts, risking dilution of the tax deductible interest.

Careful monitoring under this scenario leaves funds readily available.  It facilitates a discretion to repay any personal (non-income-producing) debt that attracts that ‘bad’ interest cost as in scenario 1. See the following extract from the ATO page but note that the comment equally applies to any interest to be claimed against income earned as is shown by our inclusion of the bracketed words:

“If you have a loan account that has a fluctuating balance due to a variety of deposits and withdrawals and is used for both private purposes and rental property (income-producing) expenses, you must keep accurate records to enable you to calculate the interest that applies to the rental property (income-producing) portion of the loan. You must separate the interest that relates to the rental property (income-producing) from any interest that relates to the private use of the fund.”

The ATO has posted a series of videos on its website explaining various aspects relating to rental property taxation matters: the one under the heading “Claiming mortgage and interest expenses for your rental property” is of particular interest in this article – and is only three minutes viewing time.

How can Continuum Financial Planners be of assistance to you?

Our experienced team of advisers is available to help you with all aspects of your financial planning, from structuring your investment portfolio, introducing you to brokers/ lenders for funding investments, formulating investment strategy, caring for your superannuation, personal risk insurance needs and estate planning – ‘we listen, we understand and we have solutions’.

To arrange to meet with one of our team for an introductory appointment at no cost to you (and no obligation implied), please call our office (on 07-34213456) or use the Contact Us facility on our website.

[Originally published in May 2015, this article is occasionally updated, most recently in December 2020.]

Close this search box.

Recent Posts