Preserving the future deductibility of my mortgage


Hi Julia,

I have a query around ensuring the future deductibility of interest on my mortgage.

I purchased a property for myself and my wife to live in around 18 months ago at a 90% LVR. The loan for this was established as interest only with an offset account, given the expectation that at some point in the future we would likely move out and use the property as an investment (and therefore would move our saved funds from the offset account to a new offset for our next PPOR).

The house is small and was built in the late 1970’s with minimal updates since that time. As such, we need to make a material renovation / extension to the property (as well as repairs), which we intend to do this year while it is still our PPOR. This is to be partly funded by additional debt.

Is there an issue with the future deductibility of the loan (ie: once it becomes a rental property) if the additional loan amount for the renovation / extension / repair work is just added to the original mortgage? If so, are there any ways that I can structure the debt so as to preserve deductibility of the original loan as well as ensure maximum deductibility of the reno loan? Also do I need to get a depreciation schedule completed prior to the renovation?

Thanks & regards


Congratulations your arrangement to date is absolutely perfect.
The repairs you are doing sound like they would actually be improvements to the property, beyond the condition it was in when you purchased it. So the whole renovation, extension and repair are all the same thing an improvement to the property which means the interest on any borrowings for them will be tax deductible when the property becomes income producing. Ideally I would like to see it all funded by debt but you have to do what you have to do.
The trick here is to be very careful about protecting the nexus. For example in Domjan’s case 2004 AAT Wilma Domjan withdrew money from the loan to pay for repairs, but in order to write a cheque she first deposited it into her private cheque account which meant the withdrawal was mixed with private funds. The AAT found that as there was no way of distinguishing whether private funds or the borrowed funds actually paid for the repair, the interest on the part of the loan that represented the draw down for the repairs was not tax deductible. Ideally electronically transfer from the loan to the repairer. If not possible make sure your cheque account has a zero balance before you put any borrowed funds in it and make sure the cheque to the repairer clears before you do anything else with the account.

Adding the borrowings for the renovations etc to the original mortgage is fine.

As the property is not producing income at the time of the renovation or immediately before, you would not qualify for a deduction for anything that is removed or destroyed. There is no current building depreciation available on the house because it was constructed before 16th Sept 1987. There will be a deduction available for deprecation on your improvements, even the “repairs” when you rent it out and maybe even a little bit for the plant and equipment currently in the house that you do not dispose of.
You will not require a quantity surveyors report to claim any of this because in the case of building depreciation (Division 43) you will only be entitled to the costs you are about to incur and you will know what they are. A quantity surveyor cannot increase the claim if the actual costs are known. When it comes to the plant and equipment that is there now and will continue you are allowed to estimate the second hand value when you bought it and then notionally depreciate it during the time you live there to give you the written down value for the start of the rental period. Any plant and equipment you buy will also be depreciated notionally during the time you live there, starting with the actual cost to you. Once you rent it out you can start to claim depreciation on the remaining value.
You do not need to spend hundreds of dollars on a quantity surveyor to work this out, your accountant can help you and still probably charge you less for the whole tax return than the quantity surveyor would charge for the report. To help your accountant get all the receipts from the reno and divide them between decline in value items and the capital works column in the table at the back of this booklet In the case of the decline in value items write the life expectancy from this list on the receipt. Your Accountant will have a simple depreciation schedule as part of their tax software that can take it from there. The only thing other than that would be to estimate the second hand value (at date of purchasing the property) of the items in the decline in value column that were in the house when you purchased it and are still there when you rent it.

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