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As at tax time, one of the most common questions ATO receives is whether interest on a loan is tax deductible. It’s an important question as the way interest expenses are treated can make a significant difference to your overall tax outcome. But the rules can be complex, and it’s easy to fall into traps without the right guidance. Here is a breakdown of the key points to keep in mind.

1. Purpose of the Loan

The tax treatment of interest always comes back to a simple principle: what was the borrowed money used for?

  • If the funds are applied to an income-producing or business activity, the interest is usually deductible.
  • If the funds are used for private purposes (such as buying a new home, car, or holiday), the interest is not deductible.

Importantly, the security for the loan does not matter. Many people assume that because a loan is secured against an income-producing asset, the interest should automatically be deductible — this is not correct.

Example – Using rental property as security:
Harry borrows against his rental property to fund the purchase of a private home. Even though the loan is secured against an income-producing asset, the funds are used privately. The result? No interest deduction is available.

2. Redraw Facilities vs Offset Accounts

While redraws and offsets may appear similar from a financial perspective, their tax outcomes are very different.

  • Redraw facility – Extra repayments reduce the loan balance. When those funds are redrawn, it’s treated as taking out a new loan. Deductibility is determined by how the redrawn funds are applied.
  • Offset account – Funds in an offset account are treated as savings. Withdrawing them doesn’t create a new loan, even though interest on the linked loan increases. Deductibility depends only on the original loan purpose.

Example 1 – Lara’s redraw facility:
Lara borrowed to buy her home. She later made extra repayments, then redrew some of those funds to invest in shares. Her loan now has mixed purposes:

  • The home loan portion remains private, with non-deductible interest.
  • The investment portion may generate deductible interest, as it funds an income-producing asset.

Example 2 – Peter’s offset account:
Peter borrowed to buy his home and placed extra funds into an offset account. Later, he withdrew money from the offset to buy shares. Even though his loan interest rises, it remains entirely non-deductible because the loan was for private purposes. The shares were purchased using Peter’s own savings, not borrowed funds.

3. Parking Borrowed Funds in an Offset Account

A common strategy we see is clients taking out a loan for future investment and temporarily placing the funds in an offset account. This approach is risky.

  • While the money sits in the offset account, it isn’t being used to produce income, so the interest is not deductible.
  • Mixing borrowed funds with existing personal money can make it impossible to trace where the funds ultimately went, creating a risk that deductions will be denied even after the money is invested.

Example – Duncan’s loan:
 Duncan takes out a loan intending to buy shares but first deposits the funds into an offset linked to his rental property loan. During this time, interest on the new loan is not deductible. If he later withdraws the funds to purchase shares, the ATO may still deny deductions, especially if the offset already contained other money.

This is an area where the mixing of funds can have lasting consequences, as once the deductibility of interest is affected it can be extremely difficult, and sometimes impossible, to restore.

4. Mixed-Purpose Loans and Record-Keeping

When a single loan funds both private and investment activities, it becomes a mixed-purpose loan. This situation complicates interest calculations, as repayments must be apportioned between the private and deductible components.

Over time, these loans can become extremely difficult to manage, especially if additional redraws or repayments are made. The risk of error is high, and taxpayers often end up either over-claiming (risking penalties) or under-claiming (missing out on deductions).

Practical tip: Keep investment borrowings completely separate from private loans wherever possible. This makes tracing and substantiating deductions straightforward.

5. ATO Audit Risk

Interest deductions are a common area of focus for the Australian Taxation Office (ATO). Because loan arrangements can be complex and easily misunderstood, the ATO pays close attention to:

  • Claims where loans are secured against rental properties but used for private purposes.
  • Deduction claims involving redraw facilities and offset accounts.
  • Mixed-purpose loans where taxpayers struggle to apportion interest correctly.
  • Situations where borrowed funds are temporarily parked in offset accounts.

If the ATO determines that deductions have been incorrectly claimed, taxpayers may face not only amended assessments but also penalties and interest charges. This makes it especially important to maintain clear records and seek advice before structuring or using loan facilities.

Need Help?

By working with us as your professional tax accountant and mortgage broker, you can be confident that your loans are structured to protect your tax position, maximise deductions, and avoid costly mistakes, giving you greater peace of mind and more control over your financial future.

Pitt Martin Group is a firm of Chartered Accountants, providing services including taxation, accounting, business consulting, self-managed superannuation funds, auditing and mortgage & finance. We spend hundreds of hours each year on training and researching new tax laws to ensure our clients can maximize legitimate tax benefit. Our contact information are phone +61292213345 or email info@pittmartingroup.com.au. Pitt Martin Group is located in the convenient transportation hub of Sydney’s central business district. Our honours include the 2018 CPA NSW President’s Award for Excellence, the 2020 Australian Small Business Champion Award Finalist, the 2021 Australia’s well-known media ‘Accountants Daily’ the Accounting Firm of the Year Award Finalist and the 2022 Start-up Firm of the Year Award Finalist, and the 2023 Hong Kong-Australia Business Association Business Award Finalist.

Pitt Martin Group qualifications include over fifteen years of professional experience in accounting industry, membership certification of the Chartered Accountants Australia and New Zealand (CA ANZ), membership certification of the Australian Society of Certified Practising Accountants (CPA), Registered Australia Tax Agents, certified External Examiner of the Law Societies of New South Wales, Victoria, and Western Australia Law Trust Accounts, membership certification of the Finance Brokers Association of Australia Limited (FBAA), Registered Agents of the Australian Securities and Investments Commission (ASIC), certified Advisor of accounting software such as XERO, QUICKBOOKS, MYOB, etc.

This content is for reference only and does not constitute advice on any individual or group’s specific situation. Any individual or group should take action only after consulting with professionals. Due to the timeliness of tax laws, we have endeavoured to provide timely and accurate information at the time of publication, but cannot guarantee that the content stated will remain applicable in the future. Please indicate the source when forwarding this content.

By Zoe Ma @ Pitt Martin Tax