In Australia, interest on investment property loans is one of the most significant tax deductions available to property investors. However, claiming this deduction isn’t always straightforward. The deductibility of interest depends not on the original purpose of the loan, but on how the funds are used over time—a principle confirmed in ATO Taxation Ruling TR 2000/2.
Unfortunately, many investors unintentionally compromise their tax position by misusing redraw facilities, repaying and reborrowing without proper structure, or refinancing for mixed purposes. These seemingly simple actions can lead to a portion of the loan being classified as private use, thereby reducing the amount of interest eligible for deduction.
Below, we outline three common traps that could affect your ability to claim full interest deductions on your investment loan—and strategies to avoid them.
Trap 1: Redrawing for Personal Use (Loan Tainting)
Using the redraw feature of an investment loan for personal expenses—such as holidays, private school fees, or buying a car— “taints” the loan. The Australian Taxation Office (ATO) treats any redraw used for private purposes as non-deductible, even if the loan was initially used for a rental property.
Example – Withdrawal
Peter originally borrowed $500,000 to buy an investment property. He later redraws $25,000 for a family holiday. His total loan becomes $525,000, but only $500,000 of it relates to investment use. From that point forward, only 95.24% of the interest is tax-deductible.
Importantly, repaying the personal component later does not automatically restore full deductibility unless the loan is formally split or restructured. Ongoing repayments must also be apportioned between the investment and private components.
Trap 2: Repaying and Redrawing Without Tracking Purpose
Some investors believe that they can repay and then redraw from an investment loan without affecting its deductibility. However, the ATO assesses each redraw as a new borrowing. The purpose of each redraw—not the loan’s history or security—is what determines deductibility.
Example – Redraw
Stewart borrowed $400,000 to purchase a rental property. Over time, he repays $100,000. Later, he redraws $50,000 for renovations on his private home. Even though the loan account remains the same, the ATO classifies this $50,000 as a new private loan. Consequently, only 85.71% of the interest on the $350,000 balance is deductible.
Had he used the redraw funds for investment property repairs, that portion would have remained deductible.
Trap 3: Refinancing with Mixed Purposes
Refinancing an existing investment loan can also result in lost deductions if part of the new loan is used for personal reasons. The ATO requires the interest to be apportioned based on the use of funds—not on what the loan is secured against.
Example – Refinancing
Julie refinances her $300,000 investment loan and increases it to $400,000. The additional $100,000 is used to pay off personal credit cards. As a result, only 75% of the interest on the new loan remains deductible.
The $100,000 allocated to private use permanently reduces the deductible portion of the interest, even though the loan continues to be secured by her rental property.
Tips to Maximise Your Investment Loan Deductions
To preserve and maximise the tax deductibility of interest on your investment loan, consider the following best practices:
- Split your loans: Use separate loan facilities for investment and personal purposes. This prevents the need to apportion interest and simplifies record-keeping.
- Use offset accounts instead of redraws: An offset account can reduce interest without altering the purpose of the loan. Importantly, withdrawing from an offset account does not “taint” the loan.
- Maintain clear records: Document the use of all borrowed funds meticulously, especially when redrawing, refinancing, or restructuring your loan. A clear audit trail helps substantiate your claims with the ATO if required.
Conclusion: Structuring Loans for Long-Term Tax Efficiency
Investment property loans can offer powerful tax benefits—but only when used correctly. The way loan funds are accessed and applied over time plays a critical role in determining the deductibility of interest. Missteps such as redrawing for private use, refinancing without purpose-based apportioning, or failing to split loans can lead to unexpected tax liabilities.
By understanding the rules and proactively managing your loan structure—with support from your accountant or financial adviser—you can ensure your interest deductions remain intact and your investment property continues to work efficiently for you at tax time.
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