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When a relationship ends, whether through divorce or separation, the emotional and financial implications can be overwhelming. While tax is probably the last thing on your mind, it’s important to understand how certain aspects of a property settlement can affect your tax position—particularly when it comes to interest deductibility.

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Let’s clear up a common misconception straight away: the costs associated with a divorce or relationship breakdown are not tax deductible. That includes legal fees, settlement payouts, and related financial arrangements. However, things get a bit more complex when jointly owned investment properties and associated loans are involved.

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Property Settlements and Interest Deductions

In the event of a property settlement following a breakup, you may need to refinance or take on additional debt to retain full ownership of a jointly held investment property. The key point to understand here is how the purpose of the borrowing affects the deductibility of the interest.

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If you borrow money solely to pay out your former partner as part of a settlement, the ATO considers this borrowing to be of a private nature. As such, interest on that portion of the loan is not deductible, even if the funds are secured against an investment property.

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A Practical Example

Imagine two individuals—let’s call them Alex and Sam—who jointly own a rental property worth $200,000, with an outstanding loan of $100,000. Upon separation, Alex agrees to retain the property and pay Sam $50,000 to settle their equity share. Since Alex doesn’t have the funds readily available, they increase the loan to $150,000: $50,000 to cover Sam’s portion of the existing loan and another $50,000 as a cash settlement.

In this scenario:

• Only the interest on the original $50,000 share of the loan Alex already owned would be deductible.
• The additional $100,000 borrowed to pay out Sam (both the share of the joint loan and the cash settlement) would not attract a deduction, as it's seen by the ATO as a private expense related to the relationship breakdown—not an investment expense.

Other Tax Implications to Consider

While Capital Gains Tax (CGT) generally doesn’t apply at the time of property transfer under a relationship breakdown, there is a catch. The person retaining the property inherits its entire cost base and history, meaning they’ll be liable for any capital gains on the full value when they eventually sell it—as if they had owned it all along.

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On a brighter note, such transfers under a formal property settlement are usually exempt from stamp duty, which can result in significant savings.

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Final Thoughts

Property and tax outcomes following a separation can be highly technical and emotionally charged. If you’re navigating a relationship breakdown that involves shared assets, it’s essential to seek professional advice. Proper structuring may help reduce the tax impact and ensure compliance with ATO guidelines.

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If you’re unsure how your situation affects your tax position or need assistance reviewing property-related deductions, don’t hesitate to reach out. It’s always better to get clarity now than face complications later.

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At Plan Tax, we specialise in guiding individuals and small business owners through complex tax matters with clarity and care. Whether you’re dealing with a property settlement or simply want to make sure you’re maximising your deductions, we’re here to help.

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Book a consultation with Plan Tax today and take the stress out of tax time—with a strategy tailored to your circumstances and goals.

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Stay tuned for further insights, including potential strategies that may help reduce the tax impact in these situations.

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