Introduction
Paying interest does not make it deductible. In Australia, the test is why you borrowed the money and what you did with it. A loan secured against an investment property can still produce non-deductible interest if you spent the funds on a car or a holiday.
Common problems include separating interest from principal and loan fees, handling loans with both private and income-producing uses, and knowing which rules apply to business, rental and investment borrowing. The ATO has said that 9 in 10 rental returns in its Random Enquiry Program contained an error (a 2022 figure, and not specific to interest).
This guide covers the general deduction test, deductible and non-deductible situations, apportionment, business limits, records, and when to get advice.
Key Takeaways
- Interest is deductible when the borrowing connects to assessable income.
- What you spent the money on matters more than what secures the loan.
- Private interest, principal repayments and many loan fees need separate treatment.
- Check current ATO guidance and entity-specific limits for your income year.
What Is an Interest Expense Deduction in Australia?
An interest deduction reduces your taxable income by the interest you incurred on borrowings used to earn assessable income. It is not a reimbursement. Assessable income minus allowable deductions equals taxable income, so a $1,000 deduction saves tax at your marginal rate, not $1,000.
The section 8-1 test
The general rule is section 8-1 of the Income Tax Assessment Act 1997. You can deduct an expense if you incur it in gaining or producing assessable income, or necessarily in carrying on a business for that purpose. It does not apply to expenses that are:
- capital in nature
- private or domestic
- connected with exempt or non-assessable non-exempt income
- denied by another provision
Use of funds decides the character
Interest takes its character from how the borrowed money is used. Four contrasting examples:
- Equipment for your business: generally deductible.
- Shares expected to pay dividends: generally deductible.
- A rental property: generally deductible while it is genuinely available for rent.
- Private consumption: not deductible.
Security does not change this. Under the principle in the ATO's TR 95/25 ruling, an income-producing asset used as security does not make interest deductible on a loan used for something else.
Who reports it
Individuals claim interest against rental, investment or business income. Sole traders use the business schedule. Partnerships and trusts calculate net income, and partners and beneficiaries pick up their share. Companies deduct interest in the company return. Reporting an expense never proves it is deductible.
Which Types of Interest Expense Are Usually Deductible?
Business borrowing
Interest on money used in carrying on a business is generally deductible. That includes working capital, inventory, premises and equipment. Keep the interest separate from capital costs of buying the asset, and from borrowing expenses such as establishment fees, which follow their own rules.
Rental property
Interest can be deductible when the loan funds buying a rental, depreciating assets, repairs, or renovations. Points to watch:
- The property must be rented or genuinely available for rent on commercial terms.
- Private use periods must be excluded.
- Co-owners who are not in business share income and expenses according to their legal interests, not a private agreement.
Shares, managed funds and ETFs
Australia has no separate "investment interest" regime like the US. Interest on borrowing used to buy shares, managed funds or ETFs is tested under the ordinary section 8-1 framework, subject to specific restrictions. For managed funds and ETFs, you cannot claim costs the trust has already deducted.
Refinancing, redraws and credit lines
Actual use controls. A refinance or redraw is traced to what the money is used for now. If you redraw $50,000 from an investment loan to renovate your home, that portion is private, even though the original loan was for investment. An investment property as collateral does not convert private debt into deductible debt.
Usually non-deductible
- Private credit-card spending
- Home loan interest on your own residence
- Private vehicles and personal consumption
- Borrowings tied to exempt or non-assessable income, apart from specific exceptions such as section 25-90
How to Calculate and Claim an Interest Expense Deduction
A practical process
- Identify the borrower. Who is legally liable for the loan?
- Identify the use of funds. Follow the money from the lender to its destination.
- Check the income connection. Is the use income-producing?
- Separate interest from principal and fees. Only interest is claimed here.
- Check special limits. Consider thin capitalisation, related-party rules and non-commercial losses.
- Keep evidence. Statements and invoices should back your calculation.
Apportioning a mixed loan
Use a reasonable, consistent method based on how the loan proceeds were applied. The ATO's example: a $400,000 loan with $380,000 used for a rental and $20,000 for a private car. With $35,000 of interest, the deductible portion is $35,000 × 380,000/400,000 = $33,250.
Repayments on a mixed loan reduce both parts proportionately. You cannot treat repayments as paying off the private portion first (see ATO ruling TR 2000/2). Separate sub-accounts for each purpose make tracing far easier.
Timing
Interest is deductible in the year you incur it, meaning a present liability, and the payment date is not necessarily decisive.
Prepayments can be claimed immediately only when the service period is 12 months or less and ends by the end of the next income year, for eligible individuals' non-business expenses and eligible businesses.
Businesses using the small business concession have a separate aggregated turnover test of under $50 million. Confirm current rules before relying on a prepayment.
Fees versus interest
Principal repayments are never deductible. Loan establishment and similar fees fall under section 25-25 and are generally spread over the shorter of the loan term, the actual repayment period, or five years. If the total is $100 or less, it is deductible immediately.
Mortgage discharge costs can be claimed under section 25-30, apportioned for income-producing use.
Where it goes on the 2026 return
| Taxpayer / category | 2025-26 item |
|---|---|
| Individual rental interest | 21 Q |
| Interest income deductions | D7 |
| Dividend deductions | D8 |
| Sole-trader business interest | P8 Q (Australian) |
| Company interest | 6 V (Australian) |
Check the current ATO instructions before lodging.
Worked example
Sam borrows $300,000 on one loan account. Of that, $240,000 buys an ETF portfolio and $60,000 pays for a family holiday. Annual interest is $18,000.
- Income-producing share: 240,000/300,000 = 80%
- Deductible interest: $14,400
- Private interest: $3,600, not deductible
Later Sam redraws $20,000 for a car. That is a new private borrowing, and the investment share of the balance falls. Sam keeps the loan statements, the purchase records and the calculation. This is a simplified illustration, not personal tax advice.
Limits, Special Rules, and Common Mistakes
Losses and negative gearing
If rental deductions exceed rental income, the loss can potentially be offset against other income, and unused losses carry forward. A deduction is not a refund. The result depends on your wider income position. The ATO notes that 2026-27 Budget changes do not apply to 2025-26.
Business interest limits
Thin capitalisation limits debt deductions for relevant entities, including foreign-controlled Australian entities and Australian entities with overseas interests. Under the 2024 amendments:
- Fixed ratio test: net debt deductions up to 30% of tax EBITDA, with conditional carry-forward for up to 15 years.
- Group ratio test: based on worldwide group gearing.
- Third-party debt test: qualifying external debt only.
- $2 million exemption: applies when the entity and its associates' debt deductions are $2 million or less.
Debt deduction creation rules
The debt deduction creation rules (Subdivision 820-EAA) can deny deductions for certain related-party financing, such as funding acquisitions of assets from associates or paying prescribed distributions. They can apply to domestic arrangements and existing debt. Foreign-owned Australian businesses should review debt terms, documentation and the commercial purpose of financing.
Special situations
- ATO interest charges: GIC and SIC incurred on or after 1 July 2025 are non-deductible, even on older debts.
- Division 7A: covers private-company loans to shareholders and associates. The benchmark rate is 8.37% for 2025-26 and 8.77% for 2026-27.
- Foreign currency and income: interest translation differs from Division 775 forex treatment, and section 25-90 is not a blanket foreign-income exception.
- Outbound interest: section 26-25 can deny deductions where required withholding is not paid.
These rules turn on your facts, so confirm the treatment before you lodge.
Common mistakes
- Claiming the full interest on a mixed-purpose loan without apportioning private use
- Relying on the security property instead of tracing how the funds were used
- Deducting principal repayments rather than interest only
- Treating all lender fees as interest when some may be capital or non-deductible
- Claiming the same cost under more than one category
- Losing records after a refinance or redraw
Records to Keep and When to Seek Professional Help
Records checklist
The ATO's rental guidance requires keeping records for five years from the later of 31 October or the actual lodgment date. Keep:
- Loan agreements and lender statements
- Drawdown documents and redraw histories
- Bank statements and invoices showing use of funds
- Refinancing documents
- Ownership percentages and rental records
- Your apportionment calculation
When to get advice
Professional review pays off when you deal with:
- Mixed-purpose borrowing
- Multiple properties or investments
- Company and trust structures
- Related-party or overseas financing
- Significant refinancing
- Thin capitalisation or debt deduction issues
For Australian businesses with Indian operations, VJM Global provides accounting outsourcing, financial reporting, tax compliance coordination and organised loan records. Confirm the scope of Australian tax advice with a qualified Australian adviser.
Frequently Asked Questions
Is interest expense tax-deductible?
Often, yes. In Australia it depends on how you used the borrowed funds and whether that use connects to assessable income. Private, capital or specifically restricted interest may not qualify.
Can I deduct investment interest on my taxes?
Interest on borrowing used for income-producing investments may be deductible. You must trace the funds, apportion any private use, get timing right and check for restrictions.
How do I know if I have an investment interest expense deduction?
Identify the investment purpose and trace the loan proceeds. Confirm the expected assessable income, remove private use, and keep supporting records.
Are investment fees deductible in 2026?
Some are. For 2025-26, ongoing management fees and certain advice on existing investments may qualify, and account-keeping fees may too. Brokerage is generally not deductible but can enter CGT calculations.
What is an interest expense deduction?
It is a reduction of taxable income for qualifying interest incurred in connection with assessable income. Australian rules and documentation requirements apply.
What are the deductible expenses for interest income?
They depend on the income-producing activity, not simply receiving interest. Borrowing interest, account fees and other investment expenses are treated separately, and Australian interest-income deductions go at D7.
