The Basic Rule
Interest paid on a loan used to purchase an income-producing investment property is generally deductible. This is one of the most straightforward deductions available to Australian property investors — and one of the largest.
On a $600,000 investment loan at 6.5% interest, the annual interest cost is $39,000. At a 37% marginal rate, this generates a $14,430 annual tax benefit.
But the rules are more complex than they appear, and there are several important nuances.
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When Interest IS Deductible
Interest is deductible when the borrowed funds are used to:
- Purchase an investment property
- Fund repairs and maintenance on an investment property
- Pay for costs directly associated with earning rental income
- Refinance an existing investment loan (interest on the refinanced amount)
- Top up an investment loan for investment purposes
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When Interest Is NOT Deductible
Interest is NOT deductible when the borrowed funds are used for:
- Private or personal purposes (holidays, car, personal expenses)
- Purchasing your own home or owner-occupied property
- Purchasing assets that don't produce assessable income
- Paying off a previous private loan
The Mixed-Use Problem: Redraw and Offset Accounts
This is where many investors inadvertently create non-deductible debt. If you have an investment property loan with a redraw facility and you draw down funds for personal use, you have effectively converted part of your investment loan into private debt.
The ATO's tracing rule: The deductibility of interest is determined by tracing how the borrowed funds are used. If you redraw $20,000 from your investment loan to fund a holiday, the interest on that $20,000 is not deductible.
Offset accounts work differently: funds sitting in an offset account are not considered drawn down. Your offset account balances reduce the interest charged, but the underlying loan remains fully investment-purpose, so the interest (after offset) remains fully deductible.
Recommendation: Never redraw from an investment loan for personal purposes. If you need to access equity for personal use, speak with your broker about a separate loan split.
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Construction Periods and Vacant Properties
Interest During Construction
If you borrow to fund the construction of an investment property, the interest during the construction period is generally deductible — even before the property is completed and generating rent. The ATO allows this because the clear purpose of the borrowing is investment.
Temporarily Vacant Properties
If your investment property is between tenants, interest remains deductible — provided:
- You are genuinely trying to rent the property (advertising, etc.)
- The vacancy is not extended without reasonable explanation
- The property has not been converted to personal use during the vacancy
Pre-Rental Vacant Land
If you purchase vacant land with the intention of building a rental property, interest during the land-holding period may be deductible from 1 July 2019 only if the property is genuinely available for rent within a reasonable time. Extended delays can jeopardise deductibility.
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Principal Is Never Deductible
Interest on your loan is deductible. The principal repayment portion of your mortgage is never deductible. This is a common point of confusion — only the interest component qualifies.
On a $600,000 loan with $3,900 monthly P&I repayments:
- Interest component: approximately $3,250/month (Year 1)
- Principal component: approximately $650/month
- Only the $3,250 interest is deductible
Loan Establishment Costs
Some borrowing costs can be deducted over the life of the loan (up to 5 years) rather than immediately. These include:
- Loan establishment fees
- Mortgage registration fees
- Stamp duty on the mortgage (not on the property transfer)
- Title search and survey costs
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Get the Full Picture
Interest deductions work in combination with depreciation to create the full tax benefit of property investment. Use Koste's free ROI Calculator to model your after-tax return including both interest and depreciation deductions.