Interest on investment property loans is one of the most significant deductions available to Australian property investors. However, the
ATO’s rules are highly specific, and compliance activity in this area has increased sharply in recent years.
Understanding how deductibility works — and where taxpayers commonly make mistakes — is essential to avoiding adjustments and an ATO
scrutiny.
The foundational ATO principle is that interest is deductible only when borrowed funds are used for an income‑producing purpose, such as acquiring or maintaining a rental property.
This rule is consistently reflected in ATO guidance on investment‑related borrowing costs. If any portion of the funds is used privately, the interest must be apportioned so that only the income‑producing component is claimed — even when most of the loan relates to an investment property.
Many taxpayers incorrectly assume that interest is deductible simply because the loan is secured by an investment property. This is not the case.
Under the ATO’s "tracing rule", deductibility is determined entirely by how the borrowed funds were used, not the security offered.
This rule applies equally to:
Where redraws or refinanced funds are applied to non‑investment purposes, the loan becomes a mixed‑purpose loan, requiring interest to be apportioned.
Refinancing does not reset the tax character of a loan. The ATO requires taxpayers to trace each component of the refinanced loan back to its original use. If refinanced funds combine investment and non‑investment purposes, the mixed‑purpose nature continues, and interest apportionment must be maintained.
A single redraw for non‑investment use can permanently contaminate the loan. Once this occurs:
Importantly, the contamination remains even if the private redraw is repaid immediately This is because each redraw is treated as a new borrowing with its own purpose.
Recent ATO compliance activity shows increased focus on redraw, refinance, and loan‑purpose behaviour. The ATO now data‑matches taxpayer claims with detailed residential loan information supplied by financial institutions, including:
This allows the ATO to identify patterns of redraws, refinances, and loan‑purpose changes. Taxpayers who continue to claim full deductibility after private redraws are being specifically targeted.
The ATO has stated that redraw misuse is a significant source of lost revenue and remains a priority compliance area.
A taxpayer originally borrowed $400,000 to purchase a rental property, making all interest deductible. Later, they redrew $30,000 from the same loan for non‑investment purposes. Through data‑matching, the ATO detected the redraw and noted that the taxpayer continued to claim 100% of the loan interest, triggering a compliance review.
Because the redraw created a mixed‑purpose loan, interest must be apportioned on a fair and reasonable basis. ATO guidance confirms that interest relating to the private‑use portion is non‑deductible, and repayments must also be split.
Example:
Accordingly, 7.5% of all future interest becomes non‑deductible.
Offset accounts provide a structural advantage because movement of funds in or out of an offset does not change the tax characteristics of the loan principal.
As a result:
Withdrawals from an offset are treated as accessing savings, not borrowed funds. This ensures the original loan’s deductibility remains intact.
Understanding these principles is essential to maintaining correct interest deductions and avoiding ATO adjustments.
For beginner investors or investors with significant portfolios, even small structural issues can create substantial tax leakage. If
you would like a strategic review of your lending arrangements — or assistance designing a clean, optimised structure — our team can help.
Contact Exacte Advisors for tailored, high‑level guidance on managing interest deductibility across any size of property holding.
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