When are you entitled to deduct interest?
If you run a business in part of your home, you are entitled to deduct part of the interest on money you borrowed to buy your home if: part of your home is set aside exclusively as a place of business and is clearly identifiable as such, and that part of the home is not readily adaptable for private use, for example, a doctor’s surgery located within a doctor’s home. If you rent out part of your home with access to general living areas on an arm’s length basis, you are entitled to deduct part of the interest on money borrowed to buy the home (see Taxation Ruling IT 2167).
In these situations you would satisfy the interest deductibility test. This means you would not obtain a full main residence exemption and so would have to pay tax on part of any capital gain made when you sell your home. You may satisfy the interest deductibility test even if you didn’t borrow money to acquire your home – you must apply it on the assumption that you did borrow money to acquire it.
You also satisfy the test if you were entitled to claim a deduction for the interest, even if you didn’t actually claim the deduction.
There is a special rule to work out the amount of your capital gain or loss if you first use your home to produce income in a way that satisfies the interest deductibility test after 20 August 1996. Last Modified: Tuesday, 30 June 2009
Main residence exemption – the effect of using your home to produce income
Where you first use your home to produce income after 20 August 1996 If you start using your home to produce income (in a way that would satisfy the interest deductibility test) for the first time after 20 August 1996, there is a special rule for working out your capital gain or loss. In this case, you are taken to have acquired your home at its market value at the time it is first used to produce income if all of the following apply: you acquired the home on or after 20 September 1985 you first used it to produce income after 20 August 1996 you would get only a part exemption because the home was used to produce assessable income during the period you owned it, and you would have been entitled to a full exemption if you had sold the home immediately before you first used it to produce income. The effect of this rule applying is that the period before the home is first used by you to produce income is not taken into account in working out the amount of any capital gain or loss. The extent of the exemption for the period after the home was first used to produce income depends on the proportion of the home used to produce income.
Example: Home first used to produce income after 20 August 1996 Louise purchased a home in December 1991 for $200,000. The home was her main residence. On 1 November 2001 she started to use 50% of the home for a consultancy business. At that time the market value of the house was $220,000. She decided to sell the property in August 2002 for $250,000. The capital gain is 50% of the proceeds less the cost base.
Percentage of use
(proceeds – cost base)
($250,000 – $220,000)
Louise is taken to have acquired the property on 1 November 2001 at a cost of $220,000. Because she is taken to have acquired it at this time, Louise is taken to have owned it for less than 12 months and therefore cannot apply the indexation or discount method to calculate her capital gain.