July 2020

Prepaying interest on an investment loan involves paying the interest normally incurred throughout the year as one upfront interest payment. The interest rate on the loan is fixed (often at a discount) for the prepayment period, which is typically 12 months.

Receiving a discounted interest rate, against standard interest rates, is not the only advantage of this strategy.  Depending on individual circumstances, prepaying interest may provide other benefits.

Why prepay mortgage interest?

Investors may choose to pay interest in advance for a number of reasons including:

  • cash flow and budgeting – utilise a lump sum available at certain times of year (for example a bonus), or simplify finances by making one prepayment of interest upfront
  • locking in a fixed annual rate – protect against possible interest rate rises over the 12 month period and possibly benefit from a discounted fixed interest rate

immediate tax deduction for prepaid interest – a tax deduction may be available in the year of payment (where certain criteria are met).  The benefit of an immediate tax deduction may be even greater where assessable income is currently higher than it is expected to be in future years if, for example, there is an expected break from the work-force.

Locking in a fixed rate

When paying interest annually in advance, a lower fixed interest rate will typically apply compared to fixed monthly payments throughout the year.


Ian currently has a $100,000 loan with a variable rate and is making regular monthly repayments.  By switching his mortgage to a fixed rate, his lender allows him to lock his interest rate in at 5.4 per cent per annum if prepaying interest annually in advance. This equates to a lump sum interest payment of $5,400 representing 12 months’ interest.  By comparison, if Ian does not want to prepay his interest annually in advance, the lender offers a fixed rate of 5.5 per cent per annum, allowing Ian to pay interest of $5,500 in 12 monthly instalments over the same period.

Tax deductibility

Prepaid interest may be tax deductible depending on individual circumstances.  Generally, a tax deduction is allowed for interest on borrowings to the extent the interest is:

  • incurred in gaining or producing assessable income, or
  • necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

The interest expense will not be deductible where it is:

  • private or domestic in nature (e.g. borrowing expenses used to purchase a private home),
  • capital in nature, or
  • relates to producing exempt or non-assessable non-exempt income.

Immediate tax deduction

Generally a deduction for prepaid interest should be apportioned over the period the interest expense relates to, resulting in some of the prepaid interest being deductible only in future income years.  However, by meeting the requirements of certain prepayment rules, it may be possible to claim an immediate tax deduction for up to 12 months of prepaid interest.

12 month rule

An immediate tax deduction can be claimed for the entire amount of the prepaid interest under the ’12 month rule’ if:
The investor is an individual and …

  • the interest is deductible non-business expenditure
  • no more than 12 months’ interest is being paid in advance
  • the 12 month period ends before the end of the following income year.

The investor is a small business entity and ….

  • the interest is deductible expenditure
  • no more than 12 months’ interest is being paid in advance
  • the 12 month period ends before the end of the following income year.

Immediate tax deduction for prepaid interest does not apply to certain tax shelter arrangements.  A typical negative gearing arrangement involving real property, listed shares or units in widely held trusts is not considered to be a tax shelter arrangement for this purpose, so prepaid interest may be immediately deductible.

Example: Susan

Susan prepays $18,000 interest in advance (representing 12 months’ interest) on her investment loan on 30 June 2019.  Susan meets the 12 month rule and may claim an immediate tax deduction for the prepaid interest of $18,000 for the 2018/19 income year.
Consider now the impact if Susan instead pays $19,500 interest in advance (representing 13 months’ of interest) on 30 June 2019, covering the period from 30 June 2019 to 31 July 2020 (a period of 398 days).
Susan will not meet the 12 month rule because the period of prepayment exceeds 12 months and does not end until after the following income year.  She will need to apportion her tax deduction (based on daily calculations) over the period the interest relates to.
The apportionment calculation is as follows:

Apportionment Deduction Year deduction claimed
$19,500 x (1/398) = $49 2018/19
$19,500 x (366/398) = $17,932 2019/20
$19,500 x (31/398) = $1,519 2020/21

More information

Further information is available from the Australian Taxation Office. See Deductions for prepaid expenses 2020.

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Macquarie Investment Management Limited (MIML) is not an authorised deposit-taking institution for the purposes of the Banking Act (Cth) 1959, and MIML’s obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542.  Macquarie Bank Limited does not guarantee or otherwise provide assurance in respect of the obligations of MIML.

This information is provided for the use of licensed financial services professionals only.  In no circumstances is it to be used by a potential investor for the purposes of making a decision about a financial product or class of products.

The information provided is not personal advice. It does not take into account the investment objectives, financial situation or needs of any particular investor and should not be relied upon as advice.  Any examples are illustrations only and any similarities to any readers’ circumstances are purely coincidental. 

While the information provided here is given in good faith and is believed to be accurate and reliable as at July 2020, it is provided by Macquarie for information only.  We will not be liable for any losses arising from reliance on this information. We recommend investors seek independent advice including taxation advice. 

MIML and Macquarie Bank Limited do not give, nor purport to give, any taxation advice. The application of taxation laws to each client depends on that client’s individual circumstances.  Accordingly, clients should seek independent professional advice on taxation implications before making any decisions about a financial product or class of products.

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