Understanding the basics of investment loan tax deductions

The tax treatment of an investment loan determines whether borrowing costs reduce your taxable income each year or sit quarantined until you sell.

Interest on borrowings used to acquire or hold residential rental property is deductible to the extent the property is rented or held to produce assessable income. That principle has not changed. What did change, from 1 July 2027, is how net rental losses on certain properties can be used. Properties acquired on or after 7:30pm AEST on 12 May 2026, unless they meet the eligible new build criteria, cannot offset rental losses against salary or wage income. Losses are instead quarantined and carried forward to offset future rental income or capital gains on residential property. Properties held before that date and time continue under the existing rules.

For construction and development professionals considering a buy-and-hold strategy on stock that does not sell immediately, or a long-term addition to a personal portfolio, the distinction between eligible new builds and other properties now carries direct financial consequences every tax year.

What remains deductible across all investment properties

Interest on the investment loan, council rates, body corporate fees, property management fees, repairs and maintenance, building depreciation and plant-and-equipment depreciation are all claimable expenses when the property is tenanted or genuinely available for rent. Stamp duty and other acquisition costs are not deductible in the year incurred but form part of the cost base for capital gains tax purposes.

The ATO requires that borrowings must be used to produce assessable income. If part of a loan is drawn for private purposes, only the portion attributable to the investment is deductible. Mixing funds in an offset account linked to an investment loan does not affect deductibility, but redrawing equity to fund non-income-producing assets will reduce the deductible component.

In our experience, subdivision and construction professionals holding completed stock as rental property while the next stage is underway often carry debt across multiple purposes. Loan structure determines what portion of interest can be claimed each year, and restructuring before settlement is simpler than attempting to separate uses retrospectively.

How negative gearing now separates new builds from established stock

Under the Treasury Laws Amendment (Tax Reform No. 1) Act 2026, properties acquired on or after 7:30pm AEST on 12 May 2026 are subject to loss quarantining unless they are eligible new residential dwellings. An eligible new build is a dwelling constructed on previously vacant land, or a dwelling that replaces an existing property where the number of dwellings increases. A knock-down rebuild that does not add to dwelling numbers does not qualify. A new build occupied for more than 12 months before sale to a subsequent investor loses negative gearing access for that purchaser.

Consider a builder who completes a duplex on a subdivided block and retains one title as rental property. The dwelling was constructed on vacant land post-subdivision, so it meets the definition. Rental losses can offset wage income, partnership distributions or other assessable income in the year incurred. If that same builder purchases an established unit off-market as a long-term hold, rental losses are quarantined and carried forward. The interest remains deductible against rental income from that property or any other residential rental income, but cannot reduce tax on construction earnings.

Capital gains tax treatment and the indexation election

From 1 July 2027, the 50 per cent capital gains tax discount for individuals, trusts and partnerships is replaced with cost base indexation using the Consumer Price Index and a minimum 30 per cent tax rate on real gains, except for eligible new build residential properties and a small number of carve-outs. Eligible new builds retain an election between the 50 per cent discount and indexation with the 30 per cent minimum. The main residence exemption and rules for affordable housing are unaffected.

Gains accrued before 1 July 2027 on properties already held continue under current rules. The change applies only to gains accruing after that date. For properties acquired from 12 May 2026 onward, the distinction between new build and established now affects both annual cash flow through loss quarantining and eventual sale proceeds through capital gains tax treatment.

A developer holding an eligible new build acquired in late 2026 and sold in 2030 will calculate the gain from 1 July 2027 onward under indexation or discount, whichever produces the lower tax. A comparable established property acquired at the same time will be indexed with the minimum rate applied, and no discount election is available.

Interest-only versus principal-and-interest structures for tax outcomes

The loan repayment type does not change what is deductible. Interest-only and principal-and-interest investment loans both allow the full interest component to be claimed. The difference lies in cash flow and the size of the deductible amount over time.

An interest-only loan maintains the original loan amount and therefore the maximum deductible interest expense each year, assuming the rate remains constant. A principal-and-interest loan reduces the outstanding balance with each payment, which lowers the interest charged and the deduction available. For negatively geared properties that still qualify under the old rules, interest-only structures maximise the annual offset against other income. For quarantined properties, the choice affects how quickly losses accumulate to carry forward.

We regularly see construction professionals use interest-only terms during project phases when cash flow is directed to development costs, then convert to principal-and-interest once the project settles and income stabilises. The tax outcome is identical in any single year; the structural choice is driven by liquidity and portfolio strategy.

Refinancing and the preservation of deductibility

Refinancing an investment loan to a new lender or product does not affect the deductibility of interest, provided the new borrowing does not exceed the outstanding balance used for income-producing purposes. If additional funds are drawn at refinance for private use, that portion is not deductible.

Lenders Mortgage Insurance paid on an investment loan refinance is deductible, either in full in the year incurred if the premium is below the ATO threshold, or amortised over five years or the loan term if shorter. Discharge fees from the old lender and application fees for the new loan are also deductible in the year paid.

Refinancing to access equity for a subsequent investment property requires the new borrowing to be structured so that the purpose of each loan portion is clear. A top-up used to fund a deposit on a second investment property generates deductible interest on that top-up amount. A top-up used to renovate the family home does not, even if the security is the investment property. The ATO traces the use of funds, not the asset securing the debt.

How APRA serviceability settings interact with tax deductions

Lenders assess investment loan applications using a serviceability buffer of 3 percentage points above the product rate and apply the debt-to-income cap introduced in February 2026. The DTI cap allows up to 20 per cent of new investor loans at 6 times income or greater, with finance for the construction of new dwellings and newly erected dwellings exempt from the cap.

Tax deductions from rental property do not increase assessable income for serviceability purposes, but projected rental income is included, typically shaded to account for vacancy and management costs. A property generating a net rental loss after deductions will reduce serviceability compared to a neutral or positive position, regardless of whether that loss can offset other income under the negative gearing rules.

For construction professionals with variable income from project-based work, the interaction between projected rental income, interest deductions and the DTI calculation determines how many investment properties can be funded simultaneously. Structuring loans to separate construction finance from investment holdings prevents cross-contamination of serviceability and ensures each facility is assessed against the appropriate exemption or cap.

Grandfathering and the transitional window

Properties held at 7:30pm AEST on 12 May 2026, including those under contract awaiting settlement at that time, retain full negative gearing under existing rules until sold. Properties acquired between that date and 30 June 2027 were subject to transitional rules allowing negative gearing until 30 June 2027 only, after which losses became quarantined unless the property is an eligible new build.

Developers who exchanged contracts on completed stock before 12 May 2026 but settled months later are grandfathered. Those who settled newly constructed dwellings after 12 May 2026, where the dwelling qualifies as an eligible new build, retain negative gearing indefinitely. Stock that was substantially complete and occupied before sale does not qualify, even if the sale occurred after the announcement.

The grandfathering provisions do not travel with the property. A grandfathered property sold to a new investor loses that status. The purchaser is subject to quarantining if the property is not an eligible new build and the purchase occurs on or after 12 May 2026.

Documenting loan purpose and apportionment

The ATO expects contemporaneous evidence that borrowings were used to acquire or hold an income-producing asset. Loan agreements, settlement statements and trust account records establish the initial purpose. Subsequent draws, redraws, refinances and offset account transactions require the same standard of documentation.

Where a line of credit or redraw facility is used for multiple purposes, apportionment is required. The simplest method is separate loan splits at establishment: one for the investment property, one for private use. If funds have already been mixed, reconstruction using bank statements and invoices is possible but administrative cost increases.

For construction professionals managing multiple projects and investment properties, we recommend loan structures that mirror the intended tax treatment from the outset. A single facility funding three townhouses, a family home renovation and an investment unit will require annual apportionment and carries higher risk of dispute. Five separate splits, each with a clear purpose, are simpler to defend and refinance independently as circumstances change.

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