ATO Interpretative Decision

ATO ID 2002/173

Income Tax

• This ATO ID has been amended by replacing the expression 'mortgage protection insurance' with 'lender's mortgage insurance' in order to more accurately describe the product discussed in the ATO ID.
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Issue

Is a deduction allowable under section 25-25 of the Income Tax Assessment Act 1997 (ITAA 1997) for all of the undeducted premium paid for lenders mortgage insurance when the taxpayer has refinanced a loan on a rental property and the policy is no longer required?

Decision

Yes. A deduction is allowable under section 25-25 of the ITAA 1997 for all of the undeducted premium paid for lenders mortgage insurance when the taxpayer has refinanced a loan on a rental property and the policy is no longer required.

Facts

The taxpayer acquired a rental property and obtained a loan to finance the property at the time of purchase. The term of the loan was 17 years.

In order to secure the loan the taxpayer paid the lenders mortgage insurance which exceeded $100.

The taxpayer claimed a borrowing expense deduction for the lenders mortgage insurance in the first 2 years of the loan.

In the third year, the taxpayer refinanced the loan and did not pay for lenders mortgage insurance on the new loan.

Reasons for Decision

Lenders mortgage insurance protects the lender from loss in the event that the borrower defaults on the loan. In the situation where an insurance claim is made, the proceeds are applied to the loan. The insurance does not protect the taxpayer's capacity to earn income from the asset. The lenders mortgage insurance premium is a one off payment prior to the asset becoming income producing and is to protect the lender from loss.

Section 25-25 of the ITAA 1997 provides that a taxpayer can deduct expenditure incurred in borrowing money to the extent that those funds are used for the purpose of producing assessable income. Lenders mortgage insurance together with other borrowing expenses incurred (for example, loan establishment fees, stamp duty on the mortgage contract, broker's commission, underwriter's fees) are borrowing costs to which section 25-25 of the ITAA 1997 would apply.

Where the amount of the borrowing expenses exceed $100 and the period of the loan is greater than 5 years, section 25-25 of the ITAA 1997 provides that the deduction for the borrowing expenses is apportioned over 5 years starting from the day the loan begins. When calculating the deductible amount in each of the income years, the remaining expenditure is the amount of the borrowing expense reduced by the maximum amount that was deductible in earlier income years.

In each year of income that a taxpayer claims a borrowing expense, the period of the loan needs to be ascertained. In the situation where a loan contract exceeds 5 years and the loan is repaid within the first 5 years, paragraph 25-25(5)(b) of the ITAA 1997 provides that the period of the loan starts on the first day that the money was borrowed and ends on the day that the loan was repaid. In applying the formula for calculating the maximum deduction available to a taxpayer under subsection 25-25(4) of the ITAA 1997, all of the remaining expenditure will be deductible in the year that the loan is repaid.

The taxpayer is therefore entitled to claim a deduction for borrowing expenses for all of the remaining expenditure of the lenders mortgage insurance on the loan under section 25-25 of the ITAA 1997 in the year that the loan was repaid.

Year of income:  Year ended 30 June 2001

Legislative References:
Income Tax Assessment Act 1997
   section 25-25
   subsection 25-25(4)
   paragraph 25-25(5)(b)

Related ATO Interpretative Decisions
ATO ID 2002/1116

Keywords
Rental expenses
Expenses of borrowing
Mortgages
Mortgage expenses
Insurance expenses

Business Line:  Small Business/Individual Taxpayers

Date of publication:  22 February 2002

ISSN: 1445-2782