Understanding Interest Tax Deductibility in Australia

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Interest deductibility is one of the most important — and often misunderstood — areas of the Australian tax system. For investors, business owners, and individuals with investment loans, getting this right can make a meaningful difference to your tax position.

However, loan structures, redraws, refinancing, and mixed-purpose borrowing can quickly complicate matters. If these are not managed carefully, interest that might otherwise be deductible can become partially or fully non-deductible.

These rules are particularly relevant for property investors, PAYG employees with investment loans, business owners, and couples who may have loans used for multiple purposes.

This guide outlines the general principles of interest deductibility, highlights common scenarios where issues arise, and explains why good record-keeping is so important.

The Core Principle
Interest is generally deductible when borrowed money is used to produce assessable income. Key points include:

• The use of the borrowed funds determines deductibility.
• The security used for the loan does not determine deductibility.
• Loan principal repayments are never deductible.
• Interest on loans used for private or domestic purposes is not deductible.

For example, interest on a loan used to purchase a rental property is generally deductible because the property is expected to generate rental income. In contrast, interest on a home loan for your primary residence is not deductible because it relates to a private expense.

Key Limitations
A few important limitations apply:

• Interest must be incurred in the income year it is claimed.
• Where a loan is used for both private and income-producing purposes, interest must be apportioned.
• From 1 July 2025, interest charged by the ATO — including the General Interest Charge (GIC) and Shortfall Interest Charge (SIC) — is no longer tax deductible.

Rental Property Loans
Interest on funds borrowed to purchase, improve, or maintain a rental property is generally deductible to the extent the property is rented or genuinely available for rent at market rates.

Deductions may be reduced or denied where:

• The property is used privately
• The property is rented to related parties at below-market rates
• The property is not genuinely available for rent

These situations may require partial apportionment of the interest.

Mixed-Purpose Loans
Where a loan is used for more than one purpose, the interest must be split between deductible and non-deductible portions based on the actual use of the borrowed funds.

This often arises when funds are redrawn from an investment loan and used for private purposes. In these cases:

• The redraw is treated as a new borrowing
• The purpose of that redraw determines deductibility
• Interest relating to the private portion is not deductible

Redraws can unintentionally create mixed-purpose loans if not carefully managed.

Negative Gearing
Negative gearing occurs when the deductible expenses associated with an investment — such as interest, rates, and maintenance — exceed the income generated from that investment.

The resulting loss may generally be offset against other taxable income.

While negative gearing is a legitimate feature of the tax system, arrangements structured primarily to create tax deductions without genuine commercial substance may attract ATO scrutiny.

Loan Structures That Can Complicate Deductibility
Certain loan features can make interest deductibility more complex.

Redraw facilities
Redrawing funds from a loan is treated as a new borrowing, meaning the purpose of the redraw determines whether the associated interest remains deductible.

Refinancing
Refinancing a loan does not change the underlying deductibility. What matters is how the original borrowed funds were used.

Split loans
Loan splits can sometimes help separate deductible and non-deductible borrowing, making record-keeping simpler. However, artificially structured arrangements designed purely to maximise deductions may be challenged.

On-lending arrangements
On-lending occurs where borrowed funds are lent to another party — for example, between related individuals, family members, or entities. To support interest deductibility for the original borrower, these arrangements generally need to reflect commercial terms.

This means documenting the loan clearly, ensuring appropriate loan terms (interest rates, repayment expectations), and demonstrating a genuine intention that the funds will be repaid. The interest rate charged on the on-lent funds should generally be comparable to the rate incurred on the original borrowing. Informal or non-commercial arrangements can make it difficult to demonstrate that the interest relates to earning assessable income.

A Simple Deductibility Check
When considering whether interest may be deductible, ask three simple questions:

• What were the borrowed funds used for?
• When was the interest incurred?
• Does the expense relate directly to earning assessable income?

If the answer to all three is yes, the interest is generally deductible.

The Importance of Record-Keeping
Clear records are essential for supporting interest deductions and avoiding complications. Useful documentation includes:

• Loan statements and bank records
• Notes on the purpose of each drawdown or redraw
• Records of refinancing transactions
• Ownership and loan documentation for jointly held investments

Maintaining clear records ensures interest deductions can be accurately calculated and supported if required.

Final Thoughts
Interest deductibility ultimately depends on the purpose and use of borrowed funds. While the basic principle is straightforward, complexities can arise with redraws, refinancing, mixed-purpose loans, on-lending, related entity arrangements, and legislative changes.

With the removal of deductibility for ATO interest charges from 1 July 2025, staying on top of loan structures and documentation is more important than ever. Understanding these rules helps avoid unintended tax outcomes and ensures interest deductions are claimed correctly.

This article is intended to provide general guidance on interest deductibility and should not be relied upon as personal tax advice. Individual circumstances may vary, and professional advice should be sought where appropriate.