Tax Deductible Interest From Your Home Loan

It’s a simple step-by-step process used by many Australians to increase their income. Borrow money from a financial institution, invest in a second property and pay off the loan with the profit made from the investment property (ie rent from tenants).

But did you know that the interest on a home loan for the purchase of an investment property is tax deductible?

To clarify, claiming a tax deduction on the interest on a loan can only be used for the loan used to purchase the investment property. It should also be used to generate income because a property that is solely for residential purposes is not eligible for tax deductions (except in certain situations where the home can be used to generate income, such as a home business or a office).

Here are a few examples of situations where tax deduction claims are not allowed on your property:

If the secured property is used for primary residence, and no income is earned from it.

Refinance your investment loan for a different purpose (such as buying another real estate).

Use of the loan for a private purchase, other than for the purchase of a home.

If the investment property is a holiday home that is not rented out, no deduction can be claimed because it does not generate rental income.

For example, if you borrow against your primary residence for the purpose of purchasing an investment property, then the interest on that loan is tax-deductible. Conversely, if the loan was against the investment property to buy a car for personal use, then the interest on that loan is not tax deductible.

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The only way a tax deduction on the interest on a home loan is if there is a direct, uninterrupted relationship between the money borrowed and the purpose for which the money was used. For example, money that resulted from a home loan should have been invested in a home.

If you happen to withdraw an investment loan for your own use (by making additional repayments on your loan, decreasing the balance of the loan), the deductible interest will be reduced. This is because the new withdrawal (transfer of money from a lending institution to a borrower) is considered not to be for investment purposes.

It is important that any investment loans are quarantined from your personal funds to maximize interest tax deductions. While it may be tempting to take extra money out of the loan for extra finances, you’re shooting yourself in the foot.

A better strategy (if only an investment debt has been incurred and you want to pay it off) is to put money in a contra account (a bank account tied to your home loan) and then withdraw that money again for your personal use. It’s also important to make sure the contra account is a correct contra account – a new withdrawal disguised as a contra account can be a major drawback for investors looking to take advantage of their tax threshold.

If you or someone you know recently bought an investment property with a home loan, talk to your accountant or financial advisor to see how your tax return can benefit.

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