Maximising Tax Relief For Interest

If you own a buy to let property minimising income tax on the rental income will no doubt be a key issue. Given the highest income tax rate is at 45% this can represent a significant reduction in your take home profits. One of the main tax deductions will be your tax deduction for interest. The tax legislation states that you'll obtain a tax deduction for any interest you incur 'wholly & exclusively' for the purposes of the lettings business. So in the straightforward scenario where you have a purchase a buy to let property with a buy to let mortgage, the interest on the mortgage will clearly be allowed as a tax deduction as it's 100% used for the purposes of the lettings business. The same rule will apply if you already own the buy to let property and you take out another loan which is used to do up or renovate the buy to let property. Again in this case the loan is 100% for the use of the buy to let property. Multiple properties If you have more than one buy to let properties this is treated as a rental business for tax purposes. This means that once a rental business has started, all activities will be treated as carried out in the course of one business. Any later expenditure leading up to the letting of the second and later properties is part of the rental business and can be deducted. So once you've got the first property up and running any future loans for any properties would be deducted from the rental business profits as a whole (even for example if the second property was not actually let yet). Source doesn't matter Another key point to bear in mind is that the source of any debt doesn't matter. As the Revenue manuals state: '…The security for borrowed funds does not determine the use of those funds. It is very common in small businesses for loans to be secured on the proprietor's home, because that is the only substantial owned asset. This is not relevant to the consideration of the use of the funds borrowed. Similarly guarantees given by another person do not affect the use of the funds…' So you could have debt secured over your main residence which would qualify for interest relief if the funds were used for the rental business. Wider application of the rule for capital withdrawals In fact though the rules go much wider than just applying if the debt was used 'wholly & exclusively' for the purposes of the letting. You could for example have a case where an individual owned a property as a main residence. This may be valued at £200,000. They may want to purchase a new property for themselves to live in, and rent out there existing main residence. In this case they could remortgage the existing property to £100,000 and use this to finance a purchase on the new main residence they were to occupy. Would the interest on the £100,000 qualify for relief? You would think not based on the 'wholly & exclusively' requirement as its clearly been used to purchase a private residence. In fact though interest on the £100,000 could qualify for relief. The Revenue state that business owners (including buy to let landlords) are entitled to withdraw their capital from the business, even though substitute funding then has to be provided by interest bearing loans. In the example above it could be regarded as funding the transfer of the property to the business at its open market value. So they'd argue that the wholly & exclusively requirement is still being met. Whether debt is raised on a main residence to purchase a BTL (clearly allowable for interest relief) or whether debt is raised on the current BTL which is then used to purchase a main residence the capital account is the same. In the latter case they're extracting cash from the business. The fact that it needs to be replaced with interest bearing debt doesn't impact on the fact that the interest is incurred wholly & exclusively for the purposes of the business. Note that the position is completely different if the capital account is overdrawn. In other words you can't be classed as extracting your capital from the business as there is no capital left. In this case if you took on debt which was extracted you'd be classed as extracting the debt -- and if it wasn't used for business purposes the interest would not then be deductible. This could be the case if you've already took significant value out of the rental business. Any debt? The above looks at debt secured on the property (ie mortgage debt). What about other forms of debt - is that also allowable? In theory it should also apply to other debts. Providing there is sufficient capital in the business the interest bearing debt is replacing the funds that have been withdrawn from the rental business.