11th July 2013
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How to claim interest relief on your residential mortgage
Most people will tell you that claiming interest relief against your PPR (principal private residence) isn't possible and in theory they are right, but by employing a little known, but simple, tax relief and indulging in some creative financial planning, you'll find that not only is it in fact entirely possible, it's also potentially very lucrative as well.
As most readers will know, you cannot claim interest relief on your PPR because it does not form any part of your property business. Because your main residence doesn't generate any rental income (the exception to this rule being the rent-a-room scheme but the income there is tax-free) you cannot claim interest relief against it.
However, you will be aware that you can claim interest relief on properties that form part of your buy-to-let portfolio. In these instances you can quite legitimately offset the interest on your mortgage payments against any rental income you receive.
So how do I get tax relief on my main residence?
The ability to claim interest relief on your main residence hinges on section 45700 of the Inland Revenue's Business Income Manual, or BIM45700 as it is more commonly known. BIM45700 was first introduced by HMRC in 2004 and what it does is give landlords the opportunity to release equity from their investment properties whilst still allowing them to offset their interest payments, regardless of what the equity release is used for.
What this means is that any landlord with equity in their portfolio can re-mortgage their property/properties and use the released funds to lower, or pay off entirely, the mortgage on their PPR. The only restriction is that the equity released cannot be greater than the market value of the property when it was first brought into the letting business. If the property had been originally bought for letting, this amount would be the purchase cost of the property. If a new PPR is being bought and it is a former main residence that is going to be let, it is the value of the former main residence on the first day that it becomes tenanted.
How do I go about doing this?
Essentially, there are 2 ways you can do this. The first would be to re-mortgage your existing buy-to-let property/portfolio, the second would be to move the equity from a previous residence that you are going to or are letting already.
Re-mortgage your existing buy-to-let property/portfolio
The following example shows how equity can be released from your investment property/portfolio to make use of this tremendous tax benefit:
Realising the potential of buy-to-let, Jim buys a property for £200,000, which he then lets out. He puts down a deposit of £60,000 and borrows the remaining £140,000 from his bank. 5 years later, Jim has the property re-valued and finds that it is now worth £300,000. This means that he now has £160,000 of equity in the property.
He then chooses to re-mortgage the property to a value of £200,000 and releases £60,000 of equity from the property. He uses the £60,000 equity release to reduce the mortgage on his main residence by £60,000, all the time still claiming interest relief on the sum released.
If we assume that Jim was paying £300 per month interest on the £60,000 mortgage, he will be able to now offset this interest payment against his rental income and save himself £3,600 per annum.
How is this possible?
It is important to remember 2 things here. The first is that if you take out a loan for the purpose of investing in a business, the interest on that loan will be allowable as a deduction against the income of the business, the second is that because the property was brought into the lettings business when it was purchased for £200,000 the additional amount of equity released has not taken the borrowing over £200,000, so the entire interest amount charged can still be offset against the rental income. Also, there are no restrictions on how the equity released must be used.
The end result of this is that Jim has managed to reduce the debt on his PPR and has moved his borrowings to his buy-to-let investment upon which interest relief can be claimed against rental income.
This is just an example of what can be achieved with a single property. Imagine if you have several properties and the ability to withdraw equity from all of them. By using this same strategy on a number of properties, you could quite easily move the entire debt from your PPR onto your buy-to-let property portfolio and claim interest relief on the whole amount.
Moving equity from a previous residence
Another way to achieve the same end result would be to re-mortgage a previous main residence. Again this strategy is best illustrated by example:
Let's assume that Stephen bought his main residence in 1998 for £100,000, and currently has a mortgage outstanding of £50,000. He has just bought a new property in which he intends to live for £500,000, with the aid of a £350,000 mortgage. His intention is to rent out his former residence, which is now worth £300,000 and he is looking to maximise the amount of loan interest on which he can claim income tax relief.
If he were to just leave things as they are he would be able to claim interest relief against his rental income in respect of the outstanding £50,000 mortgage. However, because the former residence is being brought into a rental business when he buys his new house, a notional balance sheet would show that £300,000 of capital has been introduced into the business less the outstanding £50,000 mortgage.
This means that there is £250,000 that is available for Stephen to draw down from the balance sheet. He is, therefore, able to borrow up to a further £250,000 against the rental property, so as to draw down his interest in the rental business. He could then use those funds to repay part of the borrowings on his new house and reduce his mortgage by £250,000.
As a result he would be able to claim tax relief against his rental income in respect of borrowings of £300,000, which will more than likely eliminate any rental profit for tax purposes.
He is able to obtain tax relief on all the interest charged on the new loan because it is funding the cost of the business asset introduced into the business.
Once again, with this little trick you can see that we have reduced the debt on the main residence and moved the borrowing to the buy-to-let property upon which interest relief can be claimed against rental income
As you can see, with a degree of creativity and a little bit of help from the taxman you can make significant tax savings by investing in property.