What Not to Do With Your Home Loan and Property Tax

Interest on the home loan you live in is not tax deductible, but interest on a loan used to buy a rental property can be. If you work in a hospital and might keep your current home when you move, how you set up your loan today can affect your tax later.

This article covers the structuring mistakes that cause problems. It is general information only, so please speak to your accountant about your own situation.

Is Home Loan Interest Tax Deductible for an Owner Occupied Home?

No. Interest on an owner occupied home loan is generally not deductible, because the home is not producing income. The ATO makes this point in its rental property examples, where a loan used to buy a new home cannot be claimed because the home is not being used to produce income.

The test is what the money was used for. It is not what the loan is secured against. The ATO gives an example where a couple's loan is secured against their rental property, but the part used to buy their new home still has no interest deduction.

For a hospital pharmacist, this matters most when you move on from a home but keep it. A home loan that was never deductible can become partly deductible once the property is rented out, but only to the extent the loan relates to earning that rent.

Keeping Your Old Home as a Rental: A Structuring Example

If you borrow against your old home to fund your next one, the borrowed amount is not deductible, even though the old home earns rent. Keeping those amounts in separate loan splits makes the numbers clear at tax time.

As an example, consider a hospital pharmacist who owes $400,000 on their current home. They want to buy a new home to live in and rent out the old one. They take a further $100,000 from the old home's equity as a deposit for the new place.

The ATO says that if a loan is used for both rental and private purposes, the interest must be split into deductible and non-deductible parts. The ATO's formula is total interest multiplied by the rental loan, divided by total borrowing.

At an illustrative 6.75% p.a., interest on $500,000 is $33,750 for a year, assuming interest only for simplicity. The rental share is $400,000 of $500,000, which gives $27,000 of deductible interest. The $100,000 funding the new home is not deductible.

The outcome is that the pharmacist sets up the $400,000 and $100,000 as a separate split loan structure from the start. Their accountant can then see which interest relates to the rental. The trade-off is more accounts to manage, and some lenders charge fees per split, so check this before you commit. If you are planning this move, our page on buying your next home explains how the lending side works.

Why Loan Purpose Matters More Than the Property Used as Security

The purpose of each loan split decides whether the interest can be claimed. The property that secures the loan does not decide it. Releasing equity to pay for a car, a holiday or your own home creates interest you cannot claim, even if the security is a rental.

That is why mixing everything into one loan causes trouble. The ATO notes that a loan used for a rental property and a private car must be apportioned, which adds work and room for error.

If you want to use equity for a purchase, speak to a broker before you draw it. Our equity release loans for pharmacists page covers how this works. The risk is that you increase your total debt, so your repayments and your overall borrowing capacity are both affected.

Should You Choose Interest Only to Boost Deductions?

Choosing interest only just for tax reasons can backfire. Interest only repayments are lower at first, but you are not paying down the loan, so you do not build equity through repayments.

When the interest only period ends, repayments switch to principal and interest over a shorter remaining term. That means they will be higher. A tax deduction on interest reduces the cost of that interest. It does not make the debt smaller.

If you are thinking about it for a rental, read our guide to interest only loans for pharmacists and ask your accountant whether it suits your income. Interest only can suit some investors, but it is worth weighing against the cost of higher repayments later.

Renting Out a Room in Your Own Home

If you rent out part of your home, you must declare the rent, and you may claim part of the home loan interest. The ATO says you aren't entitled to the full main residence exemption from capital gains tax, so part of any gain on sale can be taxed.

The ATO adds that you can only claim expenses for the periods the room was actually rented. The claim also depends on how much of the home is used to earn rent. Keep records of rent received, the days rented and the area used.

The trade-off is a possible capital gains tax bill when you sell. Your accountant can tell you how this applies to you before you take on a tenant.

Using Debt Recycling Without Treating It as a Tax Shortcut

Debt recycling is a strategy that shifts debt from non-deductible to deductible over time. It is not a shortcut, and it carries investment risk. If the investments fall in value, you still owe the debt.

It also relies on strict record keeping and clear loan splits. Our debt recycling page explains the concept. Get tax advice from your accountant and a licensed financial adviser before you try it.

Getting the Loan Structure Right From the Start

A hospital pharmacist's income can include penalty rates and overtime, and lenders may treat these differently in a home loan application. A broker can show you how different lenders assess your pay, so you know your likely loan amount before you apply. You can read about home loans for hospital pharmacists and how getting loan pre-approval works.

A linked offset account is worth asking about if you plan to keep your home. Ask your accountant how an offset balance could affect the interest on a loan you later claim, before you set it up. Offset accounts can also come with a higher rate or an annual fee, depending on the lender.

Talk to us before you sign anything. Call one of our team or book an appointment at a time that works for you, and we will map out a home loan structure that suits your plans. Then take it to your accountant for the tax side.

Frequently Asked Questions