When you sell a rental property, the money you make might not be enough to cover the loan you took out to buy it. This raises the question: can you still deduct the interest on your loan after you've sold the property, even though you're no longer earning income from it?
The good news is that you generally can keep deducting the interest. The key is that the interest charges must be connected to the loan you took out for a property that used to earn you income. This holds true whether you were involved in business or just investment activities. This principle is outlined in paragraph 10 of TR 2004/4.
According to the 'occasion test' from the tax rulings, if your expenses (like interest) stem from past income-generating activities (such as a loan for a property you rented out), you can usually deduct them. This is supported by several court cases and Tax Ruling TR 2004/4. The Australian Taxation Office (ATO) also offers some practical advice for handling these situations:
Application of Sale Proceeds: You should use any money from the sale of the property to pay down the loan.
Legal Right to Repay Early: Just having the option to pay off the loan early doesn't impact the ability to deduct interest.
Ability to Repay Loan: If legally or financially you can't repay the loan, it's presumed the loan remains because it's tied to past income-generating activities.
Re-financing: If you refinance the loan after selling the property, this alone doesn’t sever the connection with your past income activities.
Length of Time: The longer the period after you stop earning income, the harder it might be to prove the interest is still related to the past income activities.
From July 1, 2019, new rules limit deductions for costs related to holding vacant land, which could affect claims for interest after selling a rental property if there’s a loan shortfall.
Should you have any questions or need assistance, feel free to reach out to Tax Ideas Accountants & Advisers at +61 2 83181545 or book an appointment through our live calendar.