Mixed-purpose loans, line-of-credit facilities, and interest deductibility into retirement

For Australian retirees and pre-retirees who have used line-of-credit facilities or redraw mortgages for a mix of investment and private purposes over their working years, the interest deductibility position is often messier than they realise — and getting the apportionment wrong can lead to the ATO reassessing several years' returns. Under the general deduction provision, section 8-1 of the Income Tax Assessment Act 1997, interest is deductible only to the extent the borrowed money is used to produce assessable income — the long-standing "use" test from FCT v Munro (1926). Where a loan is used for mixed purposes — partly for income-producing investments and partly for private spending such as renovations, weddings, travel or school fees — the interest must be split, and only the investment-purpose part is deductible. For retirees who have built up tangled loan arrangements over decades, cleaning up the structures and documenting the apportionment is essential to keeping interest deductions defensible into the lower-marginal-rate retirement years.

The apportionment rule for line-of-credit and redraw facilities is set out in Taxation Ruling TR 2000/2. Interest on a mixed-purpose loan is deductible in the proportion the outstanding balance is attributable to income-producing use: if a $500,000 loan has $300,000 attributable to investments and $200,000 to private spending, 60% of the interest is deductible. The catch is in how repayments work. Where you repay more than the minimum on a single mixed account, you cannot notionally direct that repayment at the private (non-deductible) portion — TR 2000/2 requires the repayment to be applied proportionately across the income-producing and private balances. An important consequence that is widely misunderstood: because repayments come off both portions in the same proportion, they preserve the existing split rather than shifting it. The investment percentage doesn't drift down as you pay the loan off; it stays put. The percentage only moves when you draw new money for a different purpose. This is exactly why a single mixed account is so hard to manage — you can never pay down "just the private part."

The clean solution is a genuine split loan — two separate sub-accounts (or two facilities), one used solely for investments and one solely for private purposes. With distinct single-purpose accounts there is nothing to apportion: each account's interest takes its character from that account's use, and you can direct repayments at the private account preferentially without touching the deductible investment account. This is ordinary, sensible structuring and is not what the anti-avoidance cases are about. What the High Court struck down in FCT v Hart [2004] HCA 26 — and what Taxation Ruling TR 98/22 addresses — was a more aggressive scheme: a split facility in which the interest on the investment sub-account was capitalised (added to the balance rather than paid) while every available dollar was redirected to extinguish the private sub-account, deliberately growing the deductible debt. The Court applied Part IVA, the general anti-avoidance rule, to deny the additional interest deductions that the capitalisation manufactured. So the line is clear: separate single-purpose accounts with ordinary repayments are fine; capitalising investment interest to inflate deductions is not. Retirees who entered "wealth optimiser"-style capitalising arrangements in the 1990s and 2000s should have their position reviewed.

The refinancing principle in Taxation Ruling TR 95/25 generally preserves deductibility when a new loan simply replaces an existing investment loan — same income-producing purpose, same investments, the new interest keeps the deductible character of the old. But if the new loan is larger than the investment balance it replaces (refinancing a $300,000 investment loan with a $400,000 loan and spending the extra $100,000 privately), the new loan is itself mixed-purpose and must be apportioned from day one. For pre-retirees refinancing to chase a lower rate or change lenders, matching the refinanced amount to the genuine investment balance — or splitting the new borrowing cleanly between purposes — is what preserves the deduction.

The disposal of an investment asset then raises a timing question that decides ongoing deductibility, and it resolves into three situations. If the loan is repaid from the sale proceeds, that is the cleanest outcome — the loan ends and the interest deduction ends with it. If the loan is retained but the proceeds are reinvested into other income-producing assets, the interest generally stays deductible, because the borrowed funds remain employed in producing assessable income. But if the loan is retained and the proceeds are used for private purposes, the interest becomes non-deductible from the date of that change — the income-producing purpose has ended and the debt has taken on a private character. The worst result for a retiree winding down geared investments is to sell the asset yet keep the loan for private spending: a debt that is no longer income-producing and no longer attached to any investment.

There is also a retirement-specific judgment call. When a retiree's marginal rate falls — because pension and super-pension income has replaced salary — an interest deduction is simply worth less. A $20,000 interest deduction saves about $9,400 at a 47% working-years marginal rate but only about $6,000 at a 30% retirement marginal rate (FY25-26). For some retirees, paying the investment loan out from available resources becomes more sensible than continuing to deduct interest, once the after-tax cost of the interest exceeds the after-tax return the borrowed funds are earning. The break-even is fact-specific — it depends on the gross return on the geared investment, the current marginal rate, and what else the money could do.

What do worked planning examples show?

These two cases show how mixed-purpose loans play out in retirement. Illustrative only — not personal advice — using FY25-26 figures.

Case 1 — Peter and Helen, both 65, retired, with a $400,000 line-of-credit secured against their home. Over the years they drew $250,000 to buy an Australian share portfolio (held 18 years, now worth $580,000) and $150,000 for private spending (children's weddings, renovations, a trip). They have been claiming 100% of the roughly $24,000 annual interest as a deduction for years. On these facts the deduction is overstated. Only the investment share of the interest is deductible: $250,000 of $400,000 is 62.5%, so about $15,000 of the $24,000 is deductible and they have been over-claiming around $9,000 a year. A common misconception is that years of repayments will have "paid down the private part" — but under TR 2000/2 repayments on a single mixed account are applied proportionately, so the 62.5% investment share has simply been preserved, not reduced; the over-claim has persisted year after year. On these facts the rational steps are to regularise the past position with the ATO by voluntary disclosure (which typically attracts reduced penalties), and to restructure the line-of-credit into a genuine split facility — a separate investment account and a separate private account — so that, going forward, repayments can be aimed squarely at the non-deductible private account and the apportionment problem disappears.

Case 2 — Maria, 62, pre-retirement, with an investment property bought 12 years ago for $450,000 (now worth $720,000). The original loan of $400,000 was used solely to buy the property and is now down to $320,000. She plans to sell at retirement in 18 months and use the proceeds to repay the loan and contribute to super. Here the loan is single-purpose, so there is nothing to apportion and the interest is fully deductible. On these facts the clean approach is to repay the entire $320,000 from the sale proceeds on settlement — the loan ends and the deduction ends tidily — and to direct the remaining proceeds to super within the contribution caps. The small business CGT concessions and the associated CGT cap super contribution won't help here, because a passive rental property is not an active asset. The trap to avoid is the opposite move — selling the property but keeping the loan and spending the freed-up cash privately — which would convert a fully deductible loan into a non-deductible private debt overnight.

For retirees with geared investments, interest deductibility is a planning area that is easy to neglect once the working years are over. The advice work is to audit the loan structures, identify mixed-purpose facilities that need splitting, document the apportionment on a fair and reasonable basis for ATO defensibility, time any asset disposal to keep the loan's purpose aligned, and weigh whether deducting interest at a lower retirement marginal rate is still the best use of the money. The single most useful move is usually the simplest: splitting a mixed-purpose loan into separate single-purpose accounts so the apportionment becomes a non-issue from then on.

Sources

• Australian Taxation Office (ATO) — Document
• Australian Taxation Office (ATO) — Print
• Australian Taxation Office (ATO) — Interest expenses
• Australian Taxation Office (ATO) — Document