What Is Interest Limitation?

28 September 2023 by Ross Barnett in Property Accounting

What Is Interest Limitation?

If you have a new build or another property that gets an exemption (social housing, some subdivisions, one house into two, and others), we can claim 100% of the interest as a tax deduction, reducing taxable profit and tax.

Let's take a look at some concrete examples to illustrate how this can work in practice:

New Build:
  • Rent $35,000
  • Other expenses (Property management, rates, insurance, accounting, repairs etc) $10,000
  • Chattels depreciation $5,000
  • Interest $30,000
  • Net Profit (loss) $(10,000).

As a loss, there is no tax to pay.

If you purchased an existing house as a rental now and don't qualify for one of the exemptions, 0% of interest is claimable under the current Interest Limitation rules.

Existing Home:
  • Rent $35,000
  • Other expenses (Property management, rates, insurance, accounting, repairs etc) $13,000
  • Chattels depreciation $2,500
  • Interest $30,000
  • Net Profit (loss) $(10,500).

However, because of the Interest Limitation in this scenario, we cannot use the interest as a deduction. As a result, we end up with a Taxable Profit of $19,500.

If your tax rate is 33%, you would owe $6,435 in taxes. Excluding depreciation since it's not a cash expense, you'd be facing a cash loss of $8,000, in addition to paying the $6,435 in taxes. So, overall, you'd be looking at a yearly loss of $14,435.

It's important to note that all these calculations are based solely on interest payments, with no part of the loan going towards repaying the principal. If you were repaying the principal, it's worth mentioning that this portion also cannot be claimed as a tax deduction.

Ready to make your mark in the world of property investment? Take the next step towards financial success today. Get in touch with our talented team at Coombe Smith Lifetime Property Accounting to start building your investment portfolio wisely.

 

Article by Ross Barnett

 

Disclaimer: This article has been prepared for the purpose of providing general information, without taking into consideration any particular person's objectives, financial situation or needs. Any opinions contained in it are held by the author as at the report date and are subject to change without notice.

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