Tax Matters: Home in on mortgage interest relief

Published on Sunday 17 April 2011 22:36

It is a great misunderstanding that tax relief has been abolished on mortgage interest.

Yes, if we're talking about relief for mortgage payments on a house that is your principal private residence, the relief has indeed been abolished.

But if you have investment properties a little-known tweak to the law means you may still benefit from the relief, even if you didn't take out a mortgage to buy the investment property in the first place.

Here's how. Previously the rule was that relief for interest paid was granted against rental income from investment properties only if the loan was secured at the time the property was originally bought.

This meant that if you were thinking of taking out a top-up mortgage on the property, relief would not be granted for the interest payable on the top up.

Under the new rules, however, the position is very different and much better. Quite simply HM Revenue and Customs (HMRC) changed the rules so that the profits of a property-letting business are to be computed in the same way as the profits of a trade are computed.

This may sound very technical and rather subtle, yet the effect is highly beneficial.

As an example, if the investment property cost you 200,000, was bought with an 80,000 mortgage and you wish to double the mortgage to 160,000, you can now get full tax relief against your rental income for the whole of the interest you pay on the increased mortgage.

The even better news is that you do not require to spend the top up mortgage on the property - you can do whatever you like with it.

A more tax efficient idea would be to use the funds to top up your personal pension. If that is done correctly you will not only obtain tax relief on the interest payable against your rental income, but the principal sum borrowed will also qualify for top rate tax relief against your overall earned income, thus producing a massive double benefit.

But what if you take matters one step further and take out a mortgage based not just on the original value of the property when you bought it, but on its current much higher value?

Although the property may have originally cost 200,000, it may now be worth, say, 350,000. What will be the position if you wish to increase the mortgage to 250,000, more than the original cost of the property?

The answer is that no relief for the interest relating to the excess borrowed over the original cost will be due… unless you are married.

If you were to transfer the investment property to your spouse, they are deemed for tax purposes to have started a new property investment business of their own and, whether they pay you for the property or not, they are taking it into their new business at its current market value of 350,000.

They can take out a mortgage up to that value and can expect to obtain tax relief for the interest paid against the rents.There is no tax on the gift between husband and wife (or vice versa) because this is exempted by the inter-spouse exemption; indeed even if they were to borrow the money to actually pay for the property there would still be no taxable gain, because of the same exemption.

Tax relief for mortgage interest is alive and well after all.

• Ronnie Ludwig is a partner in Saffery Champness Chartered Accountants and chairman of the firm's private wealth group