Investment property interest is deductible when the property produces assessable income, but the way you structure the loan and document your intent determines what you can actually claim.
Self-employed contractors face closer scrutiny on both loan serviceability and tax deductions because income can fluctuate and the line between business and personal expenses requires careful management. The Australian Taxation Office watches investment property claims closely, particularly where the borrower is self-employed, and a poorly structured loan can cost you thousands in lost deductions or trigger an audit years after settlement.
Interest Deductibility Depends on Loan Purpose, Not Security
Interest on an investment loan is deductible only to the extent the borrowed funds are used to acquire or hold income-producing property. If you use a portion of the loan for private purposes, that portion of the interest becomes non-deductible regardless of whether the loan is secured against the investment property. Consider a contractor who borrows against an investment property to purchase a vehicle. If the vehicle is used for private purposes, the interest on that portion of the loan is not deductible even though the security is an income-producing asset. The deduction follows the use of funds, not the asset securing the debt.
Keeping loan purposes separate from the outset avoids the need to apportion interest claims across multiple uses, which becomes complex and difficult to defend if the ATO requests substantiation. When you refinance or draw down equity, the purpose of each new advance must be documented at the time of drawdown.
Negative Gearing Under the New Rules From 2027-28
Losses from established residential investment properties acquired after 12 May 2026 can be offset only against income from other residential properties from the 2027-28 income year. Excess losses carry forward to future years and can offset residential property income or capital gains on residential property. Properties held at 12 May 2026 and new builds purchased after that date remain fully deductible against all income, including salary and wages, under grandfathering provisions in the Treasury Laws Amendment (Tax Reform No. 1) Act 2026.
For contractors in Sydney considering an established unit or townhouse as an investment, the change to negative gearing means the immediate tax benefit of a loss-making property is deferred unless you hold multiple residential investments generating positive income. In our experience, contractors with variable income benefit from cash flow certainty, so purchasing a property that generates a loss now repayable only against future residential income requires a longer hold period and a clear strategy for portfolio growth. If you plan to acquire multiple properties over time, the ability to offset losses across your residential portfolio remains intact, but the diversification benefit of offsetting property losses against contracting income is removed for properties acquired after 12 May 2026.
Deductible Expenses Beyond Interest
Council rates, landlord insurance, property management fees, repairs and maintenance, and depreciation on the building and plant and equipment are deductible for the period the property is rented or genuinely available for rent. Borrowing costs, including loan establishment fees and LMI premiums, are deductible over five years or the term of the loan, whichever is shorter. Body corporate fees for units and townhouses are fully deductible. Stamp duty on the property purchase is not deductible but forms part of the cost base for capital gains tax purposes.
The distinction between repairs and capital improvements matters. Repairs restore the property to its previous condition and are immediately deductible. Capital improvements add value or functionality and must be depreciated over time. Replacing a damaged hot water system with a similar unit is a repair. Installing a new hot water system where none existed, or upgrading to a significantly higher specification, is a capital improvement. Self-employed contractors often manage property maintenance directly, and keeping detailed invoices and photographs at the time of work is essential to substantiate the nature and timing of the expense.
Structuring Loans to Preserve Deductibility Over Time
Using an offset account rather than making extra repayments preserves the deductible loan balance. Extra repayments reduce the principal, and when you later redraw those funds for any purpose, the interest on the redrawn amount is deductible only if the redraw is used for an income-producing purpose. Funds held in an offset account reduce interest charges without altering the loan balance, so the full loan remains deductible as long as the original purpose was income production.
Consider a contractor who purchases an investment property and later redraws funds to cover a cash flow gap in their business. If the redraw is used for business purposes, the interest on that portion may be deductible as a business expense, but the apportionment and substantiation become complicated. If the redraw is used for private purposes, the interest becomes non-deductible even though the loan is secured against an investment property. Keeping the investment loan untouched and using a separate facility or offset funds for other purposes maintains a clear audit trail and full deductibility on the investment loan.
Interest-Only Loans and Tax Planning
Interest-only repayments maximise the deductible interest expense in the early years of ownership, which can be useful when you expect income to rise over time or when you are building a portfolio and want to preserve cash flow for additional deposits. The loan balance does not reduce during the interest-only period, so the deductible interest amount remains constant. When the loan reverts to principal and interest, the deductible interest begins to decline as the balance reduces.
Self-employed contractors often prefer interest-only terms on investment property finance to preserve working capital and manage uneven income. Lenders typically offer interest-only periods of up to five years on residential investment loans, and the loan must meet serviceability requirements on a principal and interest basis even if the initial term is interest-only. From a tax perspective, the interest-only structure defers principal repayment and keeps the deductible amount higher, but it also means the loan balance remains unchanged, so you are not building equity through repayments during that period. Equity growth depends entirely on capital appreciation.
Documentation and Record Keeping for Self-Employed Borrowers
The ATO requires investors to keep records for five years after the relevant tax return is lodged. For self-employed contractors, maintaining a clear separation between business and personal expenses, and between different loan purposes, is critical. Loan statements, rental income records, invoices for deductible expenses, and evidence of the property being available for rent must all be retained.
When you refinance an investment loan, the new loan must be used to discharge the original investment loan for the interest to remain fully deductible. If you refinance and draw additional funds for another purpose, the interest on the new advance is deductible only according to the use of those funds. Contractors who refinance to consolidate debt or access equity for business purposes need to document the use of each component at the time of settlement to preserve the correct apportionment of deductions.
Capital Gains Tax and Cost Base Indexation From July 2027
From 1 July 2027, capital gains on residential investment properties are calculated using cost base indexation and a 30 per cent minimum tax rate on real gains accruing after that date. The 50 per cent discount continues to apply to gains accruing before 1 July 2027. For properties purchased before 1 July 2027 and sold after that date, gains are split into a pre-July 2027 portion taxed under the existing discount rules and a post-July 2027 portion subject to indexation and the minimum rate.
Eligible new builds retain access to the 50 per cent discount as an alternative to indexation, so contractors purchasing newly constructed properties have the option to choose the most favourable treatment at the time of disposal. The shift to indexation favours longer hold periods because inflation adjustments compound over time, reducing the taxable gain. For contractors with variable income who may be on a lower marginal rate in some years, the 30 per cent minimum rate on indexed gains may result in higher tax than the discount method, so the choice between methods depends on the individual's tax position at the time of sale.
Loan Structuring and Borrowing Capacity for Contractors
Lenders assess self-employed borrowers using tax returns, business activity statements, and accountant-prepared financials. Contractors who maximise deductions to reduce taxable income may find their borrowing capacity constrained because lenders calculate serviceability based on declared income after deductions. Balancing tax minimisation with borrowing capacity requires planning, particularly when building a property portfolio.
In a scenario where a contractor earns strong gross income but shows minimal taxable profit due to legitimate deductions, some lenders will assess serviceability using alternative methods, including gross income with reasonable business expense assumptions, or asset-based lending supported by the equity position. Structuring your tax affairs to maintain sufficient declared income in the years leading up to a property purchase improves access to investment loan products with lower rates and higher LVR limits. Working with an accountant and a broker who understands both tax strategy and lender policy ensures you are not locked out of opportunities due to a short-term tax decision.
Call one of our team or book an appointment at a time that works for you. We work with contractors across Sydney and understand how to structure investment loans that meet lender requirements and preserve every legitimate deduction under the new tax rules.
Frequently Asked Questions
Can I claim interest on an investment loan if I use some of the funds for personal expenses?
Interest is deductible only to the extent the borrowed funds are used to acquire or hold income-producing property. If you use part of the loan for personal purposes, that portion of the interest becomes non-deductible. The deduction follows the use of funds, not the security.
What happens to negative gearing if I buy an established investment property after May 2026?
From the 2027-28 income year, losses on established properties acquired after 12 May 2026 can only be offset against income from other residential properties. Excess losses carry forward to future years. Properties held at 12 May 2026 and eligible new builds remain fully deductible against all income.
Why should I use an offset account instead of making extra repayments on an investment loan?
Extra repayments reduce the loan balance, and if you later redraw those funds for a non-income purpose, the interest on the redrawn amount is not deductible. Funds in an offset account reduce interest without changing the loan balance, preserving full deductibility on the original investment loan.
How does the new capital gains tax indexation work from July 2027?
From 1 July 2027, gains are calculated using cost base indexation with CPI and a 30 per cent minimum tax rate on real gains. The 50 per cent discount still applies to gains accruing before that date. Eligible new builds can choose between indexation and the discount at the time of sale.
How do lenders assess borrowing capacity for self-employed contractors claiming investment property deductions?
Lenders use tax returns and financials after deductions, so maximising deductions to reduce taxable income can limit borrowing capacity. Some lenders offer alternative serviceability methods using gross income with reasonable expense assumptions, particularly where strong equity or asset position supports the application.
