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TonyTax
TonyTax, Tax Consultant
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I bought my first house in 1998 and then took out some equity

Resolved Question:

I bought my first house in 1998 and then took out some equity in 2007 through an additional mortgage to buy a second home (where I still live).
I rent out the first house and have been claiming tax relief on the additional mortgage I took out. I have now been told that I can only claim tax relief on the original mortgage and not the additional mortgage - is this correct?
Submitted: 2 years ago.
Category: Tax
Expert:  TonyTax replied 2 years ago.
Hi.

Who has told you that you are not entitled to tax relief on the interest paid on that part of the mortgage you used to buy your current home? Can you tell me what the first property cost to buy, how much the outstanding mortgage was before you increased it, how much you increased it by and what the first property was worth when it was first let and the amount of the outstanding mortgage on it at that time.
Customer: replied 2 years ago.

Hi


 


I bought the first house for £42,500 in Feb 1997. I had it valued in April 2007 and it was apparently worth £155,000. The mortgage left on it was £33,000. I borrowed money against it from my Mother initially (£102,000) and then took out a 'proper' Buy to Let mortgage in 2010 for £82,000 (I had paid off a lot of capital to Mother and still owe her £6,700). I have been paying Mother interest on the loan and claiming tax relief on this and the interest payments from the mortgage company.


 


The Inland Revenue picked me out for a tax investigation and the inspector has just come back and said that I'm only entitled to claim tax relief on the original £33,000 mortgage. She is saying that my return is wrong because i have claimed the interest on the re-mortgage which was used to fund my private residence and therefore is not allowable.

Expert:  TonyTax replied 2 years ago.
Thanks. Can we clarify a few points please?

1 When was the first property first let? If it wasn't in 2007, what was its value when it was first let?

2 Was the loan your mother made to you officially secured on the first property? Did you use those funds to buy your current home?

3 What did you do with the £82,000 you borrowed in 2010? How much was the property worth when you took this loan out in 2010?
Customer: replied 2 years ago.

Hi


The property was let straight away, May 2007, there were only a couple of days from my moving out to my new property and the place being rented out.


The loan from my Mother was as a relatively informal agreement - I had been offered a Let to Buy mortgage but being new to renting wasn't sure if it would work out so borrowed the money from Mother instead so if needs be, I could sell the property without being tied into a formal agreement with a bank. I agreed to pay her the same rate of interest as the loan I had been offered (5.29%)


Yes the funds were used to buy my current home.


The £82,000 was used to pay back money to my Mother.


The property was worth approx £135,000 / £140,000 in 2010.

Expert:  TonyTax replied 2 years ago.
Thanks.

Leave this with me while I draft my answer. There are a few things I need to consider so please bear with me.
Expert:  TonyTax replied 2 years ago.

Hi again.

As the £102,000 you borrowed from your mother was not used for an allowable business purpose, the interest on that loan should not have been claimed as a deduction from your rental income. There is no connection between the loan from your mother and your first property as it wasn't formally secured against your first property. At least, that is the inference I gathered from what you said in response to my question about whether the loan was secured on the first property. On that basis, HMRC is correct in saying that relief for interest is only available on the mortgage outstanding at that time of £33,000.

However, take a look at Example 2 in the HMRC manual, page BIM45700 here. You introduced capital of £155,000 into a rental business in 2007. The outstanding mortgage was £33,000 so you had equity in the rental business of £122,000. You borrowed £82,000 against that property in 2010 to repay your mother. Since your equity capital of £122,000 is being used in a rental business and is more than £82,000, you are entitled to take that out at any time either by selling the property or borrowing against it and if you borrow against it, the interest you pay will be deductible from the rental income. It does not matter what the released capital is used for as you are simply withdrawing it from your rental business and re-financing the business by way of a mortgage. You could say HMRC is partially correct and partially incorrect.

The only way you can borrow an amount in excess of the equity you have in the business when the property is first let and get a deduction for the interest against your rental income is if you use the raised funds for a business purpose such as buying another property to let.

I have access to many other articles and chapters in books on this subject which back up HMRC's own example but if you don't arrange things properly, you will lose tax relief on interest payments.

I hope this helps but let me know if you have any further questions.

Customer: replied 2 years ago.

Hi


So you're saying that if there was documentary evidence the original loan from my Mother was secured against the house, the tax inspector is right?


If the rental business started after I had secured the loan, does that not count?


What about the mortgage taken out in 2010 - can I claim tax relief on those interest payments?


Thanks

Expert:  TonyTax replied 2 years ago.
If the loan from your mother had been secured against the house, you would have been able to claim the interest. There doesn't appear to be a link so the tax office is right. Your sentence has it the other way around.

Either the loan was secured on the house or it wasn't. The example I gave you makes it clear. Whatever loans are in place before the rental business started are allowable.

You can claim the 2010 interest payments. My answer says as much: "the interest you pay will be deductible from the rental income".
Customer: replied 2 years ago.

Thanks for that - can I just clarify one last point please - the £82,000 mortgage taken out in 2010 was used to repay Mother. Obviously this loan was taken out after the rental started in 2007, so for Inland Revenue purposes, I can take out equity from the house after the rental started for my own use?

Expert:  TonyTax replied 2 years ago.
Yes, you can.
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