Articles

Interest Payable on Rental Business Mortgages

The interest payable on loans used to buy land or property which is used in your rental business, or on loans to fund repairs, improvements or alterations of your properties, is deductible in calculating the profits or losses of your rental business in the same way as any other property expenses.

Guidance published recently in the Inland Revenue’s internal manuals seems to benefit the buy to let investor considerably. The key phrase issued by the Inland Revenue would appear to be “Proprietors of businesses are entitled to withdraw their capital from the business, even though this funding then has to be provided by interest bearing loans”. This at first glance may not seem too important, but has wide implications for the buy to let investor as can be seen from the Inland Revenue’s example below:

Inland Revenue Example

Mr A owns a flat in London, which was purchased some ten years ago for £125,000. The mortgage on the property is £80,000. Mr A has been offered a job in Holland and intends to move there to live and work for the foreseeable future. He makes the decision to keep his London Flat and rent it whilst he is away. The London flat now has a value of £375,000.

The key issue is the balance sheet of Mr A’s capital account.

Opening balance sheet of Mr A’s rental business shows:

Mr A renegotiates his mortgage on the flat to convert it into a buy to let mortgage and borrows an additional £125,000, which he uses to buy a property in Holland.

The balance sheet of Mr A’s business now shows:

Despite the additional borrowings not being used to fund Mr A’s UK property business, the additional interest he will be paying is allowable in full as a deduction against his UK rental income as his business capital account is not overdrawn.

The Inland Revenue’s own manuals clearly indicate that provided any remortgaged funds do not exceed the amount of the proprietor’s capital account the interest is fully tax deductible. This therefore, would imply that Mr A has the ability to borrow an additional £170,000 of tax deductible finance from his property business!!

Further Example

Mr T originally purchased a property for £250,000 with the aid of a £200,000 buy to let mortgage. The property has increased in value over the years to £350,000 and he decides to borrow an additional £50,000.

The balance sheet of Mr T’s rental business was originally:

The balance sheet of Mr T’s business after the remortgage now shows:

Based on the Inland Revenue’s own internal guidance is does not matter how Mr T spends the £50,000 drawn from his business. He could for example purchase a Porsche or a holiday home in Bulgaria!! The key is that Mr T’s property capital account is not overdrawn.

If Mr T has a mortgage on his own home it would seem sensible to use the £50,000 to reduce the borrowings on his home loan as no tax relief is obtained on main residence borrowings. Even though the interest rate on a buy to let mortgage will be marginally higher that a main residence mortgage the interest is deductible at an individual’s marginal tax rate. Therefore, a buy to let rate of 5.5% becomes an effective rate of 3.3% after adjusting for higher rate tax relief.

It would be prudent to draw up a balance sheet for each property owned to enable the capital account position to be determined. Any remortgaged funds need to be documented should the Inspector of taxes raise an enquiry into the mortgage interest expenditure claimed.

Source: Article produced by our business partners Taxation Solutions Limited.

Provisional approval number MAB 2293.