Tuesday, April 08, 2008

How to Pay Off Your Residential Mortgage and Claim Interest Relief

Here is an outline a tax-efficient strategy for property investors with a mortgage on their main residence.

Now, doesn’t that sound like a great idea – getting tax relief on the mortgage interest that you pay on your main residence?

Well, you will be pleased to hear that it is possible by following a simple (and relatively unknown) tax relief and some creative financial planning.

The Basics
As most property investors are aware, it is not possible to claim interest relief on your main residence. This is because your main residence does not form part of the property business.
Therefore, because no rental income is received from your main residence, (exception being the rent-a-room-relief), you cannot claim interest relief against your income.
However, you will also be aware that you can claim interest relief on properties that form part of your property business i.e. your buy-to-let portfolio. In such instances you can offset your mortgage interest on your let properties against any rental income received.

Introducing BIM45700
BIM 45700 was first introduced by us back in October 2004. In an article, we identified how this little known strategy gave landlords the opportunity to release equity from their investment properties and offset the interest regardless of what the equity release was used for.
The only restriction is that the equity release cannot be greater than the market value of the property when it is brought into the letting business. If the property had been originally bought for letting, this amount would be the purchase cost of the property.

So How Do We Get Tax Relief on Our Main Residence?
Well there are two ways to achieve this:
Remortgaging existing buy-to-let property/portfolio
Those of you who have or are growing a buy-to-let portfolio are likely to have equity in the property. The example below shows how/when this equity can be released to give you a tax benefit.

John buys a rental property for £200,000. He provides a £40,000 deposit and borrows £160,000. 5 years later the property has increased to £250,000. This means that he has £90,000 equity in the property.
He decides to remortgage the property to a value of £200,000 thus releasing £40,000 of equity from the property. He uses the £40,000 equity release to reduce the mortgage on his main residence by £40,000 and still claims interest relief on this equity release.

Now you will be asking how is this possible?
Well, don’t forget 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.
So, if say, for example he is paying £200 a month interest on the £40,000 then he will be able to now offset this interest against his rental income.

Reduced debt on the main residence
Borrowing moved to buy-to let property upon which interest relief can be claimed against the rental income

Now, this is just an example of a single property. Imagine if you have 2, 3, 4 properties or more and have the ability to withdraw equity as in the example shown above?

By using this same strategy on a number of properties, you could shift the entire debt from your main residence on to your buy-to-let property portfolio and claim interest relief on the entire amount!

Moving Equity from Previous Residence
Another useful tax trick is to remortgage a previous main residence. Again this strategy is best illustrated by an example.

Lisa and John buy a property for £100,000 (£20,000 deposit and £80,000 mortgage). They live in the property for five years and then decide to buy another property. Instead of selling their existing residence they decide to get onto the buy-to-let ladder and let the property out.
The cost of the new property is £200,000, and at the time of letting, their previous residence is worth £150,000.

They increase their debt on the previous residence from £80,000 to £150,000 i.e. they release £70,000 of equity. They then use this equity release to reduce their mortgage on their main residence by £70,000.

Once again, because the additional amount of equity released has not taken the borrowing over £150,000, (the price when it was brought into the lettings business), the entire interest amount charged can still be offset against the rental income. If the interest charged on this amount was £250 per month then this is a significant saving every month.

Once again, with this little trick we have:
Reduced debt on the main residence
Moved borrowing to buy-to let property upon which interest relief can be claimed against the rental income

As you can see, sometimes with a little bit of creativity you can bring significant tax savings! It is possible to get even more creative with this tax break but we’ll leave these strategies for another time.

Article courtesy of Arthur Weller & Amer Siddiq
Arthur Weller and Amer Siddiq are contributors to Property Tax Portal.


greg said...

They are so many different process is given "How to Pay Off Your Residential Mortgage and Claim Interest Relief". Remortgaging existing buy-to-let property/portfolio are some ways to perform in Equity Release

Anonymous said...

Hi Shaun,

Fascinating...many thanks. On a similar theme, bearing in mind that a buy-to-let mortgage is more expensive than a typical owner occupier mortgage, can I borrow against my own PPR (home) to nominally fund the rental property, i.e. although the funds are borrowed (at a more competitive rate) asgainst my PPR, can that loan be treated as part of the rental business debt and as such can it be eligible as a cost to offset against the rental income (and thus reduce the tax liability). Or did we just go full circle and disappear somewhere!??



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