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Rental dilemma

Person A resides in Property 1 - main residence. Decides he needs a bigger property so remortgages property 1 to purchase property 2. He then moves into property 2 as his main residence.

He then rents out property 1.

Dilemma is, is the mortgage interest on the re-mortgage allowable against the rental income for property 1, even though it was used solely to purchase his new main residence?

Can anyone help?
Danny Mehta

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06th Sep 2004 17:44

Even better than that...
"IR approach appears that as long as 'capital account' is not overdrawn, any loan in place at time property is transferred to rental business is treated as financing that business."

Example 2 of BIM45700 goes beyond that and does not restrict the allowable interest merely to that payable on the loan in place when capital introduced.

Is it not made clear that (disregarding subsequent capital improvements and profits/losses) loans of up to the Market Value of the property when introduced to the business will qualify?

JP

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06th Sep 2004 11:09

IR150 paragraphs Wholly & exclusively!
Costs you incur in obtaining loan finance for your rental business are generally deductible in computing rental business profits provided they relate wholly and exclusively to property you let out on a commercial basis.

Interest payable on loans used to buy land or property which is used in your rental business, or on loans to fund repairs, improvements or alterations, is deductible in computing the profits or losses of your rental business in the same way as other expenses.
184. Similarly, interest payable under hire purchase agreements or on an overdraft is deductible where the asset is used for business purposes.
185. The normal rental business rules apply, including the ‘wholly and exclusively’
rule (see paragraph 119 onwards) and the rules governing the timing of relief (see paragraph 64 onwards). You can’t, for example, deduct interest on a private loan, such as a loan used to buy your private residence. See paragraph 194 for more about your home.

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06th Sep 2004 11:45

Scorer v Olin Energy
"It does not necessarily follow that the purposes of the loan can be ascertained by looking at the immediate use to which the borrower applies the money."

IR approach appears that as long as 'capital account' is not overdrawn, any loan in place at time property is transferred to rental business is treated as financing that business. However, I agree that it does seem unusual to grant a deduction in such circumstances, particularly given the wording in IR150 paras.183 et seq. In particular,

"186. Similarly, the interest on a loan or overdraft may not be allowable, or only
part may be allowable, where the borrowing is, for example, used:...
• for the provision of the private funds you take out from your rental business."

I think, even in the IR example, it is difficult to argue that the additional loan has not been used to provide private funds. However, those are the instructions in the Revenue manual and I would challenge the Inspector to admit they are wrong!

It appears that this is similar to withdrawal of partnership capital. Subject to recent decisions, the advice was always to draw capital first, and replace with loan. The other way round would always fall foul.

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By Anonymous
03rd Sep 2004 14:14

According to the Inland Revenue....
.... as long as the total mortgage does not exceed the value of the property when it is first rented out, then all of the mortgage interest will be allowed against the rental income, regardless of what the money is used for.

See the Inland Revenue's Business Income Manual at paragraph 45700, Example 2.

Hope this helps.

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By Anonymous
03rd Sep 2004 13:37

yes but
The part of the original loan remaining outstanding (which is then re-mortgaged) that relates to the purchase of house 1 is allowable (the interest charges, that is) against rents received from House 1 rental.

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03rd Sep 2004 13:19

No
The test for deductibility as I understand it is - were the borrowed funds used for an income-producing purpose? Sounds like they were used for a private purpose, so not allowed as an expense against Sch A income.

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