Alarm as taxman takes interest

A NEW tax ruling sounds a warning to some of Australia's 1.5 million property investors and may cost them thousands of dollars in tax breaks, experts say.

The Australian Taxation Office has flagged it will crack down on property investors claiming deductions for interest expenses on certain types of loan arrangements.

Property owners using some or all of the rental income from an investment property to pay off their own home loan while adding the interest from the investment loan to the principal and claiming it as a deduction would come under scrutiny, accountants BDO said.

In a determination last month, the ATO said it would reject such arrangements.

''People are trying to divert all the rental income off into their home loan. That's pushing it too far and that's what the Tax Office is getting at,'' said Age columnist and tax expert Max Newnham.

The change would affect one of the ''big ticket'' items, claiming interest paid, which landlords rely on when lodging their tax return, said BDO property tax specialist Eddie Chung. ''Any loan arrangement that incorporates features that would effectively give rise to the capitalisation of interest on an investment loan while the loan repayments are used to pay down the principal of a private loan is now under the spotlight,'' he said.

Investors relying on a larger tax deduction to reduce their expenses would feel a ''real financial squeeze'', said Andrew Gardiner of the National Tax and Accountants Association.

The ATO's determination will apply retrospectively and could affect a landlord's past income and deductions, potentially costing them thousands of dollars.

Property investors should be conservative and avoid claiming deductions for any compounding interest on their investment loan, Mr Gardiner said.

It was difficult to quantify how many investors would be affected, Mr Newnham said. ''Of our clients, I'd be surprised if 10 per cent were doing it,'' he said.