The way it was

Following recent revenue clarifications, there have been two common misunderstandings for property investors: -

1. I own a buy-to-let property. I take out a top-up mortgage but I will spend the money on something that is totally unrelated – say a new car, school fees, a holiday or maybe improvements to my home.
   
   Assumption
   I will not be able to set the additional mortgage interest against my rental income for tax.
   
   
2. I am moving house. However, rather than sell my existing home, I think I will continue to own it, and start to let it out. I am going to raise a loan on my existing home to help me buy my new place.
   
   Assumption
   I do not expect I will be able to get tax relief for the loan interest.

Both of these statements were soundly based, but they are now based on old law/practice.

The way it is now

All you have to do, if you own a buy-to-let property, is picture a balance sheet. That’s easy for an accountant to say! The answers to the two misunderstandings outlined will then become apparent.

1. Buy-to-let top-up mortgages

Let’s say your investment property cost you £225,000, which you bought with the aid of an £100,000 mortgage. You now want to increase the mortgage to £185,000, but will spend the extra £85,000 in a way that has nothing to do with your buy-to-let property. Nonetheless, your imaginary balance sheet will still look fine as you have not exceeded the cost of the property.

Property (cost plus improvements)		£225,000
Funded by:
	Owner’s capital (£125k original less £85k now borrowed)	40,000
	Mortgage (£100k original plus new advance £85k)	185,000
		£225,000

You should now get full tax relief, against your rental income, for the whole of the interest you pay on the increased mortgage. That is because these days, the rules for property letting businesses mirror those for trading businesses.

Health warning! The total borrowing must not exceed the original cost of the investment property.

2. Main residence becomes investment property

Again, picture the imaginary balance sheet: provided your capital account is not overdrawn, you get full relief for the interest paid!! (And you thought that tax relief for home loan interest had been abolished!) But, on how much? The original cost of the property?

Now here’s even better news!

On the BTL example, we said that if you wanted to borrow an amount which is even greater than the original cost of the buy-to-let property you couldn’t. But the rule is different - and better – if the property wasn’t originally bought as an investment property.

Property (cost 1970 £15,000 but valued at time when converted into investment business)	£350,000
Owner’s capital	100,000
Existing mortgage (after prior remortgages)	250,000
	£350,000

No overdrawn capital account, so no disallowance of interest!

Conclusion

If you own a buy-to-let property, you can take out a new mortgage on it (or top up the existing mortgage) and obtain tax relief for the interest against your rental income. The funds that are released to you can be used for anything you want. The only limitation here is that the total borrowing must not exceed the original cost of the property.

The same applies if you now move out of your main residence and begin to let it out, except that instead, you can borrow in full up to today’s market value!


If you would like any assistance with the calculations or even help with claiming back tax from prior years please contact Steve Cook, Tax Partner on either steve@nunn-hayward.com or 01753 888211.