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TaxationWeb by Arthur Weller and Amer Siddiq

Arthur Weller and Amer Siddiq, authors of '27 Proven Property Tax Saving Strategies' outline a potential tax planning strategy - courtesy of the Inland Revenue's own guidance manuals!

Introduction

Ever since Maurice Parry-Wingfield (Tax Director at Deloitte), mentioned paragraph 45700 from the Inland Revenue Business Income Manual, accountants and tax specialists have been highlighting the potentially huge benefits this can bring about for landlords.

In the 18 September 2004 edition of the Financial Times, Maurice Parry-Wingfield drew attention to the fact that paragraph 45700 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.

In paragraph 45700, the Inland Revenue provides the following example:

‘Mr A owns a flat in central London, which he bought ten years ago for £125,000. He has a mortgage of £80,000 on the property. He has been offered a job in Holland and is moving there to live and work. He intends to come back to the UK at some time. He decides to keep his flat and rent it out while he is away. His London flat now has a market value of £375,000……He renegotiates his mortgage on the flat to convert it to a buy to let mortgage and borrows a further £125,000. He withdraws the £125,000 which he then uses to buy a flat in Rotterdam.

The Inland Revenue goes on to say that ‘Although he has withdrawn capital from the business the interest on the mortgage loan is allowable in full because it is funding the transfer of the property to the business at its open market value at the time the business started. The capital account is not overdrawn’.

Here are some more case studies to explain the benefits of this tax break for landlords and homeowners.

Case Study A – Benefiting from buying off-plan

Alex buys an investment property off plan in January 2002 for £125,000. When the property is completed in June 2003 it is worth £175,000. Upon completion Alex decides to let the property and therefore the property is transferred to the lettings business at a value of £175,000.

This means that in the future years, Alex can remortgage the property for an additional £50,000 and still offset the interest that is charged. It does not matter what the £50,000 equity release is used for, it can be offset against the rental income, as the market value of the property at the time of letting was £175,000.

So if Alex wants to use the £50,000 equity to buy a new sports car then the interest charged on the equity release can be offset against the rental income.

It is important to understand that Alex is not allowed to offset any interest charges for equity that is released above £175,000 unless it is used for the purpose of the lettings business.

So this means that if in future years the property is valued at £300,000, then although he may be able to release additional equity above £175,000 he will not be able to offset interest on this amount if it used for anything other than the lettings business.

Case Study B – Benefiting from letting out your own home and increasing house prices

John and Louise buy a house in 1987 for £50,000. They live in it for 14 years and then decide to move to a bigger house. Instead of selling the existing house they decide to let it out.

Over the 10 years the house has been fully paid for and therefore there is no outstanding mortgage.

The value of the house in 2001 is £190,000. The new house that they have seen is £300,000.

In order to provide the deposit for the new house, they re-mortgage their existing house on a buy-to-let mortgage for £152,000. This amount is used to fund the deposit on the new residence, which means that they only need to borrow £148,000.

The entire interest that is charged on the buy-to-let mortgage can be offset against the rental income. This is because it is below the market value of the property at the time of letting.

Two years later the original property is worth £250,000. In order to reduce the mortgage on their private residence, they are able to release an additional £38,000 of equity on the buy-to-let mortgage. This means that they have mortgaged to the amount of £190,000 on this property.

Again, because they have not gone over the market value of the property at the time of letting they are able to offset the entire interest charges against the rental income.

At the same time they have also successfully managed to reduce the interest on their private residence by an additional £38,000!

Once again, if the original property is remortgaged above £190,000 and the money is not used for the purpose of the lettings business then the interest charged cannot be offset against the rental income.

November 2004

Arthur Weller and Amer Siddiq

This article has been reproduced with the permission of the Property Tax Portal, ‘a website solely dedicated to helping landlords pay less property in tax and boost their profits’. For more information, please visit http://property-tax-portal.co.uk/cmd.php?af=189188