Posted by James Pearson on 16 Feb 2018
HMRC have introduced a restriction to the amount of mortgage interest relief that is available for property businesses. Even so, if you have a property letting business you may find that restructuring your borrowing between properties could still have substantial tax benefits.
New Tax Relief on Mortgage Restriction
From the 2017/18 tax year, a restriction is being phased in to limit the mortgage interest relief available for individual landlords to reduce property rental income tax to the basic rate of income tax.
The restriction removes all deductions for finance costs before the tax is calculated. A tax deduction is then given to reduce the individual’s tax liability by up to 20% of the mortgage interest.
This change hits properties with significant finance costs the hardest, i.e. where large mortgages have been used to fund the property purchases. Some landlords could end up paying income tax on loss-making rental properties. Maximising the amount of interest against which relief can be claimed is, therefore, more important than ever.
Maximising Your Tax Relief on Mortgage Interest
If you own a property other than your main residence, it may be that you are not maximising the amount of tax relief you can claim on mortgage interest. This is because HMRC will allow interest on a loan taken out for business purposes to be deducted when calculating the profits of that business. This in effect means that if you are able to swap a non-business loan for a business loan you will be able to increase the amount of interest relief available.
A mortgage used to purchase your main residence is not a business loan, and consequently, no mortgage interest tax relief is available, but a loan taken out to fund a property letting business is a business loan and the mortgage interest is an allowable expense that can be set against rental income.
You can’t always simply swap a non-business loan for a business loan by increasing the amount of borrowing on the rental property and using the cash raised to pay off the mortgage on your main residence. This is because depending on your circumstances, HMRC may be able to say that you did not increase the borrowing for business purposes but just to allow the business owner to draw more cash. However, such a swap may be possible if the borrowing on the business property is less than the market value of the property when you first introduced it to the letting business.
The market value of the property when introduced to the business is your capital contribution to the business, and that initial contribution is business related, meaning that any borrowing that funded that initial contribution is a business related loan. If the borrowing on the rental property is currently less than the property’s market value at the date of introduction to the business, the borrowing can be increased up to that value and full interest relief will still be available, even if the additional cash is raised against the mortgage on your main residence.
Can I Claim Tax Relief on Mortgage Interest? Example Tax Relief Available
Your main residence is worth £400,000, with a £200,000 mortgage. You also have a rental business, and the rental property is worth £350,000 with a £200,000 loan secured against it. You are able to claim interest relief on the £200,000 loan on the rental property but not the £200,000 on your main residence.
If the rental property was worth £300,000 when you first started to let it, you could increase the overall business borrowings from £200,000 to £300,000. Since the borrowing of £300,000 does not exceed the market value of the rental property when introduced to the business, you will be able to claim interest relief on the full £300,000 rental property loan, even if you use the extra £100,000 of cash released to reduce the borrowing on your main residence, or on other spending of your choice.
If you do decide to reduce your main residence loan, this will mean that you still have £400,000 of borrowing on the two properties. However, rather than only £200,000 of the loan being eligible for interest relief, £300,000 of the loan can now benefit, saving 50% more tax than before. This could offset some of the impact of the mortgage interest relief restriction.
This a complicated area and we would recommend you talk to us before taking action. In some cases, there can also be savings available even if the rental property is owned by a limited company.
If you would like any advice regarding tax relief for residential mortgages or would simply like to discuss other ways in which we could help you or your business, please contact us on 01962 856 990 or firstname.lastname@example.org
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