Transfer of residential rental properties in relationship split — how do interest limitation rules apply?

Transfer of residential rental properties in relationship split — how do interest limitation rules apply?

QUESTION:
A husband and wife partnership owned several rental properties. The partnership had loans over the rental properties taken out before 27 March 2021.

The husband and wife finalised the splitting of their assets in August 2021. Part of the divorce settlement was that the husband took over 2 of the rental properties. He had to take out a loan in his own name to repay the joint loan.

Is the husband able to claim the interest on the loan that he took out in August 2021 to repay the existing loan, drawn down prior to 27 March 2021, that was in joint names?

ANSWER:
A partnership is tax transparent. Therefore, the husband is treated as owning half the residential properties and being liable for half the partnership's loans for tax purposes.

While the interest limitation rules now deny interest deductions incurred in respect of “disallowed residential property” purchased on or after 27 March 2021, interest from loans drawn down before that date (“grandparented transitional loans”) is being progressively phased out over a period of 4 years, ending on 31 March 2025. See s DH 8 of the Income Tax Act 2007.

Husband’s half interest in the properties

A grandparented transitional loan includes a loan taken out for refinancing a pre-27 March 2021 loan (ie where a subsequent loan is taken out to pay off the original loan). See s DH 5(5)(e). Therefore, with regard to the husband’s deemed half interest in the partnership properties and loans, 50% of the new loan drawn down is refinancing 50% of the partnership loan he was treated as already having. The interest in relation to that portion of the loan will therefore still be deductible (but subject to the phase-out) on the basis it is simply a refinancing.

Transfer of wife's half interest in the properties

The transfer of the wife's 50% of the properties to the husband (assuming the properties were transferred under a settlement of relationship property as defined in s FB 1B) will be subject to rollover relief. See s DH 5(5)(d). Where disallowed residential property is transferred under a settlement of relationship property entered into between 27 March 2021 and 31 March 2025, any loan drawn down or taken over by the transferee (ie the husband) is treated as a grandparented transitional loan.

Interest on the loan for the residential rental properties will, therefore, continue to be deductible under the interest phase-out to the extent that the loan is equal to or less than the amount of the partnership's loan when the property was transferred.

In summary, the husband's new loan to refinance the partnership loans, to the extent it does not exceed the partnership loan, should be a grandparented transitional loan.

​References:
Income Tax Act 2007, ss DH 1, DH 2, DH 5, DH 7, DH 8, FB 1B, FB 3A.

This article has been reproduced from CCH / TEO Q & A Service: