Tax is complicated at the best of times, not least when it comes to real estate. As an investor, the complexity could be overwhelming but, if you can get a handle on it, the potential deductions and savings could be the difference between just breaking even and making a significant profit.
There are various tax deduction opportunities when it comes to refinancing your investment property, but the rules are specific and purpose-driven. This comprehensive guide explains which refinance costs are tax-deductible for Australian rental properties, so that you can maximise your claims while staying compliant with the ATO.
What Refinance Costs Are Tax Deductible for Rental Property?
Refinancing comes with a range of costs, from administration fees to interest payments, but whether or not those costs are deductible depends largely on how you use the funds.
As a general rule, you’ll apply the “purpose test” and costs for investment purposes could be deductible, but costs for personal use usually aren’t. Whether or not you live in or use the property yourself is therefore crucial.
You’ll then need to apply different tax treatments for different components of the refinance. Where costs are deductible, some will be deductible in full straight away. Others may need to be amortised, where the deduction is spread over multiple tax years.
Deductible Refinance Costs for Investment Properties
Which costs apply for deductions? If the refinance is being used for investment purposes, in most cases you can deduct:
- Loan establishment fees
- Lender's mortgage insurance premiums (usually amortised)
- Lender’s valuation fees
- Mortgage broker fees
- Title search fees
- Mortgage registration and discharge fees
- Legal fees related to the loan documentation
You should always seek personalised, professional advice with any tax questions. Remember as well to keep careful records of all these costs so that you can provide the necessary documentation if needed.
Are Mortgage Refinance Fees Tax Deductible?
Yes, mortgage refinance fees can be tax deductible, but with specific conditions. In all cases, the rule we’ve referred to already applies: the finance must be for investment, income-producing purposes, not personal use.
If your borrowing expenses are over $100, they have to be amortised over the loan period or over five years, whichever is shorter. One-off establishment fees are usually amortised too, while annual package fees are generally deductible in the year you incur them.
Specific Treatment of Common Refinance Fees
All your different refinancing fees receive a specific tax treatment, so make sure you know which is which:
1. Application/Establishment Fees
You can deduct application and establishment fees, provided they’re for investment purposes, but you need to amortise them if they’re over $100.
For example, if you refinance your investment property loan for $400,000, investing $300,000 in improvements and $100,000 for personal use with a $1,000 application fee, you would amortise the deductible portion (75% or $750) over five years, i.e., $150 per year.
2. Valuation Fees
If your lender requires you to pay a valuation fee for your investment loan, the costs are deductible immediately if the fee is less than $100, or amortised over five years or the lifetime of the loan, whichever is shorter, if more than that.
3. Mortgage Discharge Fees
You might incur mortgage discharge fees when you pay off the balance of your mortgage. The fees are deductible for investment loans, but they’re treated differently depending on whether you’re refinancing or selling.
If you pay off your existing mortgage because you’re refinancing, the fee is deductible immediately if $100 or less, otherwise it can be amortised over five years or the lifetime of the loan, whichever is shorter.
If you’re selling, you treat the fee as a cost and reduce your capital gains tax, but you can’t deduct it on your tax return.
4. Break Fees on Fixed Rate Loans
You’ll pay a break fee if you pay off the balance of your mortgage before the end of your fixed term. The fee will usually be deductible when used on the same property, because the loan continues to be used for income-producing purposes, but not for personal purposes. If you’re selling the property, like a discharge fee, it forms part of your cost base for capital gains tax.
Is Refinance Interest Tax Deductible?
Like most of the other costs we’ve discussed here, you can generally deduct the interest on your loan provided the loan is for income-producing purposes, including cash-out refinancing. Tracing rules apply, so it is the way in which you use the funds rather than the property against which the loan is secured that matters.
Unlike many one-off costs, ongoing interest is deductible in the year it is incurred. For example, if you refinance the home where you live to invest in a rental property, your interest is usually tax deductible.
Debt recycling goes a step further by gradually replacing non-deductible debt with deductible investment debt, typically by overpaying on your home loan and then reborrowing that money for an investment. Over time, you shift your loan balance from personal (non-deductible) debt to investment (deductible) debt.
Navigating Mixed-Purpose Refinancing
If you use the loan for mixed purposes, you’ll need to apportion the amount you deduct, i.e. if 50% goes on investment and 50% on yourself, only 50% of the interest is deductible. You also need to consider your strategy for separating the investment and personal elements of the loan, for example through separate accounts or split loan arrangements.
The ATO accepts loan splitting when done correctly, but they will scrutinise anything that artificially increases deductions. They may ask you to prove the investment-related portion of any refinanced debt, so keep careful records.
Non-Deductible Refinance Costs
Not every expense qualifies for tax deductions. For example, as well as any expenses for personal purposes, you won’t be able to claim:
- Costs related to the property acquisition itself
- Stamp duty on the property transfer
- Building insurance premiums
- Principal repayments
Tax Treatment of Cash-Out Refinancing
A cash-out refinance is treated in much the same way as other loans when it comes to tax. You can only claim deductions on the proportion of the loan being used for investment purposes, so consider how you can manage your loan in the most efficient way. As always, keep careful records.
Timing of Deductions for Refinance Costs
In terms of timing, when can refinance costs be claimed? It varies by cost:
- Borrowing expenses should be amortised over 5 years or the loan term, whichever is shorter.
- You should use pro-rata calculations for the first and last years, where the loan wasn’t held for the full year.
- You can make an immediate deduction for expenses of $100 or less.
- If you prepay interest (e.g., a 12-month interest payment made upfront), it may be deductible in the year it is paid, but specific ATO rules apply, particularly for individuals and small businesses.
To maximise tax deductions, consider timing your refinancing early in the financial year to claim a larger first-year deduction under pro-rata rules, prepaying interest before 30 June if eligible for an immediate deduction, and ensuring any borrowing expenses under $100 are incurred in a high-income year to maximise tax benefits.
Practical Case Studies for Australian Property Investors
Let’s look at some examples of how this works in practice:
Standard Investment Property Refinancing
Sarah refinances her $500,000 investment property loan to secure a lower interest rate and uses the funds for rental property purposes, meaning the refinancing costs are fully deductible.
Mixed-Purpose Refinancing
Tom refinances his $400,000 investment loan, increasing it to $500,000, using $100,000 for personal expenses, meaning only 80% of his interest and borrowing costs are now deductible.
Owner-Occupier to Investment Property Conversion
Emma refinances her home loan after moving out and turning the property into a rental, making future interest deductible, but past non-investment-related costs remain non-deductible.
Debt Recycling
James pays down his home loan and then refinances to borrow $50,000 to purchase shares, converting a portion of his non-deductible debt into deductible investment debt over time.
Loan Restructuring
Lisa splits her loan into separate investment and personal accounts, ensuring clear tax deductibility and avoiding complex apportionment calculations.
Documentation and Compliance Requirements
To ensure you can manage your taxes efficiently, implement a robust record-keeping system for your rental property refinancing. Keep detailed digital and physical copies of all relevant documents including:
- Loan documentation: Original loan contracts, refinance agreements, statements showing principal and interest breakdowns, and any correspondence with lenders about loan terms.
- Purpose declarations: Written records made at the time of refinancing that clearly state the intended purpose of the funds (investment vs. personal use).
- Transaction evidence: Bank statements showing the movement of refinanced funds to verify how they were actually used.
- Apportionment calculations: Spreadsheets or notes detailing how you calculated deductible percentages for mixed-purpose loans.
- Property expenses: Invoices and receipts for any property improvements or repairs funded by the refinance.
- Settlement statements: Documentation from your conveyancer or solicitor related to the refinancing process.
- Chronological timeline: A dated record of all significant events related to the property and loan to help establish the sequence of transactions.
Consider creating a dedicated digital folder structure organised by financial year, with subfolders for each property and refinancing event. Back up these records to cloud storage and retain them for at least five years after your tax return is lodged (though keeping them for the entire ownership period of the property is ideal for capital gains tax purposes). This comprehensive approach will not only ensure you claim all eligible deductions, but also don’t claim deductions that you shouldn’t. It also means that if you face any scrutiny from the ATO that you have all the evidence you need to hand.
Calculating tax deductions is complex with any aspect of your finances, not least with real estate. By familiarising yourself with the rules, keeping careful records, and timing your plans and investments carefully, you can make the most of your available deductions and ensure you remain fully compliant.
It’s always important to keep in mind that everyone's situation is a bit different, so it's always a good idea to have a chat with your accountant or tax professional before making any big decisions about your investment property.
FAQs
What refinance costs are tax deductible for rental property in Australia?
For investment properties, tax-deductible refinance costs typically include loan establishment fees, lender's mortgage insurance premiums, valuation fees, mortgage broker fees, title search fees, mortgage registration and discharge fees, and legal fees related to loan documentation. However, these costs are only deductible if the refinanced funds are used for investment purposes. Expenses over $100 generally need to be amortised over five years or the loan term (whichever is shorter).
Are mortgage refinance fees tax deductible when refinancing an investment property?
Yes, mortgage refinance fees are tax deductible for investment properties, provided the refinanced loan is used for income-producing purposes. This includes application fees, establishment fees, and other borrowing costs. If these fees exceed $100, they must be amortised over five years or the loan term (whichever is shorter). Annual package fees are generally deductible in the year they're incurred.
Is refinance interest tax deductible for my rental property?
Interest on a refinanced loan is tax deductible if the loan is used for income-producing purposes. The ATO applies "tracing rules," meaning it's the purpose of the borrowed funds that determines deductibility, not the security for the loan. If you refinance for mixed purposes (partly investment, partly personal), only the portion used for investment purposes qualifies for interest deductions. You must keep detailed records to substantiate your claims.
How do I handle tax deductions for a cash-out refinance on my investment property?
For a cash-out refinance, tax deductions follow the same principles as other refinancing: the deductibility depends on how you use the additional funds. If you use the extra cash for investment purposes (like property improvements or purchasing another investment), the interest and costs are generally deductible. If used for personal expenses, that portion isn't deductible. It's important to maintain separate loan accounts or detailed records for mixed-purpose refinancing.
What refinance costs are NOT tax deductible for rental properties?
Non-deductible refinance costs include expenses related to the property acquisition itself (rather than the loan), stamp duty on property transfer, building insurance premiums, and principal repayments. Additionally, any portion of refinance costs attributable to personal use (such as home renovations or holidays) is not deductible.
How are break fees on fixed-rate investment loans treated for tax purposes?
Break fees paid when refinancing a fixed-rate investment loan are generally tax deductible if the loan continues to be used for income-producing purposes. If you're selling the investment property, the break fee is not directly deductible but is added to your cost base for capital gains tax calculations.
When can I claim tax deductions for my rental property refinance costs?
The timing of deductions varies: borrowing expenses over $100 must be amortised over 5 years or the loan term (whichever is shorter); expenses of $100 or less can be deducted immediately; and interest is deductible in the year it's incurred. For partial years, pro-rata calculations apply. Prepaid interest may be deductible in the year it's paid, subject to specific ATO rules.
How does debt recycling work for tax deductions on investment properties?
Debt recycling involves strategically replacing non-deductible debt (like your home loan) with deductible investment debt. You make extra repayments on your personal loan, then reborrow those funds for investment purposes. This gradually converts your non-deductible debt into tax-deductible investment debt. However, this strategy requires careful planning and documentation to satisfy ATO requirements.
