Residential investment property loans and tax compliance

The ATO has announced the commencement of a data-matching program for property investors to acquire residential investment property loan data from authorised financial institutions.

Sample audits conducted under the ATO random enquiry program indicate a net tax gap of $9 billion for the 2019–20 income year attributable to incorrect reporting of rental property income and expenses.

A significant driver of the gap was incorrect apportioning of loan interest costs where the loan was refinanced or redrawn for private purposes.

Data matching and tax compliance

The ATO will use the data to ascertain information about rental property loans including information such as repayments, interest charged, and borrowing expenses. This information will be used to identify, assess and treat several tax compliance matters including:

Lodgement – confirming that taxpayers with rental properties are lodging tax returns and the relevant rental property schedule on or before the relevant due date;
Income tax – confirming taxpayers with a rental property are correctly reporting interest on loan and borrowing expense deductions in their rental property schedules and associated income tax return labels;
Capital gains tax (CGT) – confirming the calculation of cost base elements used to determine the net capital gain or loss on a rental property used to generate income.

After a return is lodged, the ATO will use the data collected to identify relevant cases for action including compliance activities and education strategies.

If a discrepancy is identified, taxpayers will be contacted by phone, letter or email. Taxpayers will then have 28 days to respond before the ATO takes any action in relation to the discrepancy.

Other matters

ATO’s residential investment property loan data matching program will run from 2021–22 to the 2025–26 income years.

The data collected by the ATO will be made available to tax professionals through pre-filling reports in Online services for agents and practitioner lodgement service (PLS) through standard business reporting (SBR) enabled software.

Individual self-preparers may also access the data collected by the ATO through myTax, specifically the rental property schedule interest on loans or borrowing expense labels and rental income tax return labels.

Mixed purpose loans

Situations will arise where a landlord refinances a rental property loan that is a mixed purpose loan. This is essentially a loan that has been partly applied for an income producing purpose (e.g., to acquire a rental property) and partly applied for a private purpose (e.g., to pay for a holiday).

A mixed purpose loan in relation to a rental property often arises where, for example:

part of the original loan (or borrowing) was used to buy the rental property and part of the loan was used for private purposes; or
funds have been withdrawn from a redraw facility linked to a rental property loan and used for private purposes (e.g., to pay for a holiday or to buy a car that is used for private purposes).

Where a landlord refinances a mixed-purpose loan, the following two key traps generally apply:

Interest on refinanced loan not fully deductible – The refinanced loan takes on the same properties as the original loan. This means that the new loan is also a mixed purpose loan and therefore takes on the same income producing and private portions (or balances) as the original loan. On this basis, interest expenses incurred on the new (or refinanced) loan are only deductible to the extent they relate to the income-earning portion of the new loan (i.e., they are not deductible to the extent they relate to the private portion of the new loan).
Subsequent repayments on mixed purpose loan must be applied proportionately – Any subsequent repayments against the mixed purpose loan must be applied proportionately against each portion of the loan balance at that time (i.e., the income producing portion and the private portion of the loan balance). This means that a taxpayer cannot direct that any subsequent repayment against the mixed purpose loan only reduces the private portion of the loan (before it then reduces the income producing portion of the loan). Refer to paragraph 44 of TR 2000/2 and to Domjan v FCT [2004] AATA 815 (Domjan’s case).

The above problems with refinancing a mixed purpose rental property loan can be avoided by using separate loans or sub-accounts. Refer to paragraphs 46 to 47 of TR 2000/2.

More specifically, refinancing an existing mixed purpose rental property loan using separate loans or sub-accounts essentially involves the following:

The original mixed purpose loan is refinanced by borrowing an equivalent amount under two separate loans or sub-accounts.
The amount borrowed under the first of these new loans or sub-accounts is equal to the income producing portion of the original mixed purpose loan, and the amount borrowed under the second new loan or sub-account is equal to the private portion of that original loan.
In this case, the new loans or sub-accounts are not mixed purpose loans, as they each relate solely to funds borrowed for an income producing use or funds borrowed for a private use.
Generally, interest incurred on the new income producing loan or sub-account is deductible, whereas interest incurred on the new private loan or sub-account is not deductible.
Principal repayments of amounts borrowed privately can be directed only to the private loan or sub-account, and are not required to be apportioned against all outstanding loan balances.

The above solution not only avoids interest expenses having to be apportioned, but it also avoids having to apply any principal repayments against both the income producing and private portions of the loan proportionately. This means that principal repayments can be directed solely to the separate private loan/sub-account, thereby reducing only the private portion of the borrowing.

Should you have any queries in relation to this program and its operation, please feel free to contact our office.
t: +61 7 3177 4120
e: advisors@hksrussell.com

Posted on June 26, 2023 by Charisse Russell - Articles