How to use an investment property to get mortgage tax relief on your home
A reader has asked a question concerning an article which we ran in the January 2005 issue of Finance Confidential — an article which provoked a great deal of interest. (Not to mention disbelief!)
It was entitled ‘Property investors: much more tax relief than you thought’.
Here’s the question.
"You say that if I remortgage my investment property, I can use the additional funds ‘for anything I want’. Does this mean that I could remortgage it to repay the loan that’s outstanding on my own home? And in this way convert a loan, which attracts no tax relief on the interest payments (my home mortgage), into one which gets relief in full (my investment property mortgage)? Surely the Inland Revenue won’t accept that?"
We think they will.
Let’s quote them.
HERE’S WHAT THE REVENUE SAY...
The Inland Revenue have gone into print on the subject of top-up mortgages in their tax inspectors’ manuals. Their comments fully bear out what we said in December:
‘Proprietors of businesses are entitled to withdraw their capital from the business, even though the substitute funding then has to be provided by interest-bearing loans... This is on the basis that the purpose of the additional borrowing is to provide working capital for the business... There will be an interest restriction if the proprietor’s capital account becomes overdrawn.’
The Revenue then go on to give this helpful example. It doesn’t take us precisely where we want to go, but it certainly gives us a strong hint.
‘Mr A owns a flat in central London, which he bought 10 years ago for £125,000. He has a mortgage of £80,000 on the property. He has been offered a job in Holland and is moving there to live and work. He intends to come back to the UK at some time. He decides to keep his flat and rent it out while he is away. His London flat now has a market value of £375,000.
The opening balance sheet of his rental business shows:
|
£ | |
| Property at market value | 375,000 |
| Less: Mortgage | 80,000 |
| £295,000 | |
| Capital account | £295,000 |
He renegotiates his mortgage on the flat to convert it into a buy-to-let mortgage and borrows a further £125,000. He withdraws this £125,000, which he then uses to buy a flat in Rotterdam.
The balance sheet at the end of Year 1 shows:
|
£ | |
| Property at market value | 375,000 |
| Less: Mortgage (80,000 + £125,000) | 205,000 |
| £170,000 | |
| Capital account: | |
| Brought forward | 295,000 |
| Less: Drawings | 125,000 |
| £170,000 |
Although he has withdrawn capital from the business, the interest on the mortgage is allowable in full because it is funding the transfer of the property to the business at its open market value at the time the business started. The capital account is not overdrawn.
It is clear from all this that the fact that he is going to Rotterdam for work reasons is irrelevant. It doesn’t matter how he spends his £125,000: provided that his capital account does not become overdrawn, the interest on the borrowing will be allowable in full.
The tax planning message now becomes self evident.
TO GET TAX RELIEF ON YOUR MORTGAGE PAYMENTS THIS IS WHAT YOU SHOULD DO...
Our suggested tax-saving strategy here is simple but hugely effective. It is designed for you if you own both:
- an investment property (with or without a mortgage)
- and a home (with a mortgage). And the recommendation (broadly) is this:
Repay the mortgage on 2, and lump it onto 1.
Do this and, all of a sudden, you’ll begin to get tax relief on the interest you pay!
REMEMBER YOUR TOTAL BORROWING IS CAPPED BY THE PROPERTY’S VALUE
There is a limit to all this of course (hence the use of the word ‘broadly’ earlier). The maximum amount you can borrow — including any existing mortgage — against your investment property (and still get tax relief for the interest) is restricted to:
- the original cost to you of the property or
- if the property was your home in the past, but has now become an investment property, its market value at the time it became a buy-to-let investment.
Most property investors will find that these parameters will give them more than enough scope to create substantial tax savings year after year. So go on, do it! Because, for property investors, home loan interest (without tax relief) can become a thing of the past.
And there’s more...
Similarly, if you are paying other sorts of non-tax allowable interest — such as if you have outstanding balances on credit cards, or under hire purchase agreements pay off those loans, and lump them onto your investment property mortgage. And start getting tax relief for the interest.
In short, huge tax savings are there for the taking. So take them!
Alan Rook is a chartered accountant who has been writing on company tax matters for the past 15 years
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