Can Home Loan Interest be Deducted on Your Tax?
The interest you pay on your residential home loan usually isn’t tax-deductible, but the interest on an investment property loan certainly is!
The reason that your residential home loan interest generally isn’t tax-deductible is because you can only claim expenses as tax deductions if they’re incurred when generating your taxable income. Your residential home is where you live, it usually doesn’t generate taxable income for you. It’s important to try and reduce or eliminate this non-tax-deductible home loan interest as quickly as you can.
Why you can deduct investment property loan interest on your tax return
Unlike your residential home loan, you can rent an investment property out to tenants. Besides your loan interest, you can also claim other investment property expenses to reduce your taxable income, such as:
- property management costs (like council rates and insurance)
- repairs and maintenance costs, and
- depreciation on property assets like furniture, appliances and carpet.
When your investment property expenses exceed your rental income, this is known as “negative gearing”. The capital growth that you may be able to achieve with a well-chosen investment property over time can exceed this shortfall between your tenant income and your expenses.
Are there residential home loan exceptions?
Yes, besides investment property loans, you can deduct residential home loan interest from your taxable income in specific circumstances:
1) if you’re running a business or you work from home, and
2) if you rent out a room in your residential home.
We’ll now look at both of these situations in turn.
Running a business or working from home
If you run a business from your residential home, or your home is your principal workplace with a dedicated work area such as a home office, you may be able to claim a portion of your home loan interest. That’s because you’re using your home to generate taxable income in these circumstances.
The proportion of home loan interest that you can deduct is usually based on the dedicated work floor space in your home. For example, if you’re using 20% of the floor space, you may be entitled to claim 20% of your home loan interest as a tax deduction. You might also be able to claim a portion of other home occupancy expenses, such as:
- council rates,
- insurance premiums,
- land taxes,
- electricity, gas, phone and cleaning costs.
If you do work from home, it’s best to get professional advice to find out the full extent of your tax deduction entitlements. It’s important to understand that tax minimisation is legal, tax avoidance is not, and it can incur heavy penalties from the Australian Taxation Office (ATO).
It’s also important to keep records of your expenses to help your accountant or tax agent work out your tax return claims, or in case your claims are ever audited by the ATO.
Renting out a room in your residential home
You may also be able to claim a portion of your residential home loan interest if you rent a room out to a tenant. In other words, if you’re a “live-in landlord”. An increasing number of Australians are doing this, using platforms like Airbnb. It’s important to understand though that you must declare the rental income you receive from any rental arrangement in your residential home before you can deduct a portion of your home loan interest (and a portion of your other home occupancy expenses as well).
Again, the amount you can claim will usually be proportional to the floor space that you’re renting out. It’s important to keep records of all your income and expenses so you can substantiate your claims, and it’s best to seek professional advice.
If you’re renting out a room to family and friends, it’s also important to charge a market rate of rent so that you’re entitled to claim your maximum tax deduction. If you don’t, it will affect the amount you can claim accordingly. For example, if you rent out your room for half the market rate, you’ll only be entitled to deduct half of the proportional interest amount on your tax return.
What about capital gains tax (CGT)?
If you claim a proportion of your residential home interest and other expenses as tax deductions, there are potential capital gains tax (CGT) implications. You’ll likely have to pay CGT on a proportion of your sales proceeds if/when you sell your home. Again, it’s best to seek professional advice if/when you’re in this situation to ensure your tax compliance.
If you don’t claim any home expenses on your tax return, your residential home is exempt from CGT when it’s sold if you make a profit on it, unlike investment properties. Your capital gain on an investment property is added on to your taxable income in the year you make the sale, but you’re entitled to claim a 50% discount on the gain if you’ve held the property for more than 12 months.
How we can help
At Qi Wealth, our experienced, expert team of tax specialists can help to ensure your tax compliance and that you don’t pay any more tax than necessary. We’ll take the time to understand your situation so we can provide you with the best possible advice. We develop long-term, trusted relationships with our clients.
Contact us today to find out how we can help you!