Tax Matters: Mortgage interest tax relief is alive and well for investment landlords

Published on Friday 31 October 2008 19:52

WITH the credit crunch now evolving into a recession, it's a good time to look at how to use tax relief to make your debt slightly less painful.

If you have an investment property, for example, it should be possible to obtain tax relief on mortgage interest, even though the government of the day abolished the relief in the mid nineties.

Here's how. In the not-so-good-old days the rule was that relief for interest paid was granted against rental income from investment properties only if the loan was obtained at the time the property was originally purchased. So if you took out a top-up mortgage on the property, relief would not be granted for the interest payable on the top up.

Under the current rules, the position is very different and much better. Quite simply HM Revenue & Customs changed the rules such that the profits from property letting are to be computed in the same way as the profits of a trade. This may sound very technical but the effect is highly beneficial.

Under the new rules, property letting is regarded as a business and consequently if you own a buy-to-let property there is now nothing to prevent you taking out a top-up mortgage and obtaining tax relief for the extra interest payable against the rents received.

For instance, if you used an 80,000 mortgage to buy an investment property costing 200,000 and wish to double the mortgage to 160,000, you can now expect to obtain 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 have to spend the top-up mortgage on the property – you can do whatever you like.

A particularly tax efficient way of using the funds would be 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 qualify for top rate tax relief against your overall earned income, producing a massive double benefit.

But what if you take matters one step further and take out a mortgage not just based 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 300,000, a sum which is much 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 wife, she is deemed for tax purposes to start a new property investment business of her own and, whether she pays you for the property or not, she is taking it into her new business at its current market value of 350,000. She can take out a mortgage up to that value and can expect to obtain tax relief for the interest paid against her rents.

Finding a lender may be difficult – but not if additional security in the shape of your main home is available – and again the funds borrowed could be used for any purpose, including clearing expensive debt, or lending it to your business if it is struggling for cash flow.

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 she were to borrow the money to actually pay you for the property there would still be no taxable gain, because of the same exemption.

Finally, what about the situation where you may be moving into a new home and letting out your existing property because current market conditions make it hard to sell? If you were to raise a mortgage on your "old" home (or top up the existing one), tax relief can be claimed on the full amount of the mortgage interest against the rents receivable, even though the funds may be used to help you to buy your new main residence. Tax relief for mortgage interest is alive and well after all.

&#149 Ronnie Ludwig is a partner in the Saffery Champness Private Wealth group