Advice from financial advisor

Advice from financial advisor

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I have a client with 2 properties. Property 1 is the main residence and property 2 is let under a Ltd Company.

This is the advice given to my client by a Financial Advisor:

"As you know client has £87,000 interest only loan on property 2, which is rented out.  The length of the lease is only 62 years so it does present some issues when looking at loans. Long term the plan is to look at leasehold extension or even freehold purchase if co- leaseholders are agreeable.

"Principal residence is property 1.  This property is valued at about £350,000 to £360,000 and has a capital repayment loan of £64,000 linked to it.

"I do have a few clients where their accountants are treating the interest payment of the additional loan (linked to the principle residence) such as this, against the investment property income where the amount of borrowings are in line with the standard terms of buy to let mortgages ( up to 75% LTV).

"So in this case, Property 2  is valued at about £206,000 and has a loan of £87,000, but client could legitimately borrow up to 75% of the value, so there is a valid argument that says that Client only has the property 1 (main residence) loan to fund the rental property."

My understanding is that he is telling her to take out a loan on her main residence because it is easier to get and the interest would then be allowable against the rental property (interest already claimed on existing mortgage). I have told her that I am not happy with this advice but that I would look into it.

Does anyone know of any circumstances where HMRC would allow this? Is the advice he is giving correct?

Replies (17)

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By User deleted
10th Jun 2014 10:52

If client had both properties ...

... in her own name I'd be more comfortable with claiming interest, depending on the arrangements.

But since the rental property in this case is held by a limited company I'm struggling to find a legitimate argument for claiming relief on personal borrowing. 

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By jaffe123
10th Jun 2014 10:57

Sorry, should be a bit clearer - The properties are both held personally. The Ltd company only handles the rental income and expenses with a legal agreement between the owner and the Ltd Co.

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By User deleted
10th Jun 2014 11:00

What is the substance ...

...of the agreement between owner and company? Why was it set up this way?

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paddle steamer
By DJKL
10th Jun 2014 11:12

Cost of the rental property

I may have missed something here but surely to relieve loan interest against the rental income the current valuation of the rental property is not relevant it is the "cost" of the rental property when it became a rental property that is on point to establish the quantum of the loan on which relief may be claimed. Not sure that which property the loan/loans are secured over is that important.

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By pauld
10th Jun 2014 11:26

Loan on property 1

Surely the additional loan on property 1 would have to be used on property 2 in order to get interest relief against rental income. Otherwise they could take out £25 on prop 1 and buy a car. The interest would not be allowable against prop 2.

Agree with DJKL where cost is relevant on prop 2, not market value.

Who's paying the tax on profit ion prop 2  - company or personal? sounds a strange arrangement. If its the company, what are the benefits?

 

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By jaffe123
10th Jun 2014 17:08

Apologies, but been out all day.

This was set up before my appointment.

Basically the client has 2 properties in her name and one is rented out to students. The rental income and all costs are reported through a limited company with a legal agreement between the client and the Ltd company giving the company authority to act for client with regards this property.

From my understanding this was set up like this because client was subject to higher rate tax.

The tax on profit is paid by the company.

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Replying to johnhemming:
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By vstrad
18th Jun 2014 14:07

Is there a contract?

jaffe123 wrote:

The rental income and all costs are reported through a limited company with a legal agreement between the client and the Ltd company giving the company authority to act for client with regards this property.

Does the Ltd Co manage the property for the client or does the Ltd Co pay the client for the right to the rental income? If there is no consideration there is no contract.

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By User deleted
10th Jun 2014 17:12

So ...

... if client is not renting the property herself, and all rental profits are taxed within the company, against what income is she hoping to claim loan interest relief?

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By The Wycher
10th Jun 2014 17:17

My understanding of the rules are that for loan interest to be reclaimable against the income from a property the loan must have been taken out to buy the property or to replace the original loan to buy or do work on the property.

In the case you have set out it looks like the IFA is suggesting that you claim the interest paid on the PPR mortgage, against the rental property just because the total of both loans would be below the standard buy to let mortgage limits.

If HMRC spotted this then I would strongly suspect they would not be happy.

I will leave open the question as to whether they will actually spot it.

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Replying to Kaylee100:
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By Swedish Chef
10th Jun 2014 17:29

I too am confused.

I share BKD's confusion.

If prop 2 is not formally rented to the Ltd Co (which subsequently sub-lets to the students), how can it possibly be part of the individual's rental business? 

 

 

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By jaffe123
10th Jun 2014 17:22

According to the advisor the interest on the new loan secured on her private residence would be deductible from company profits because they would fall below the 75% loan ratio for buy-to-lets.

His reason for securing the loan on the main residence is the short lease life left on the rental property which makes it difficult to raise a new mortgage on that property.

Client has not told me of any plans to use the funds on the rental property which is just one reason I am not happy with the advice. Can't contact her until tomorrow.

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By Paul D Utherone
10th Jun 2014 17:36

... a twist on a theme exercised previously

and with the company in the way then as BKD suggests you have a problem.

Otherwise they presumably have in mind Example 2 at BIM45700 and withdrawing free capital from the property business to replace with the loan, leaving the loan free to use for any purpose ... and we've been around that one often :)

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By Chris08
10th Jun 2014 18:23

It has merit

Rental income is considered a business for tax purposes, and financing of that business follows normal business/trade rules.  There requirement that the loan had to be used to buy the property was withdrawn in the late 90s.

Interest is therefore allowable if it has been used to fund the rental business.  Full stop. That simple.

It is perfectly acceptable for a mortgage on the main home to be used to fund a rental business. How the loan is secured is entirely irrelevant to the question of allowability. And as mortgages on main homes often have a lower interest rate, it is often the better arrangement.

Furthermore, a business can restructure its finance for any reason and at any time.  If it decides to release equity that has built up in a property by taking out further finance then it is entitled to do so.  So timing of loans is also irrelevant. 

So what the IFA says does indeed have some merit.

HOWEVER, as stated above by others – the company receiving the rents is unable to claim deduction for interest paid on a mortgage that is not in the company’s name.  There are ways of addressing this through the Company to owner lease, but has this happened here, and have the necessary disclosures been made in the owners tax returns.

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By User deleted
10th Jun 2014 19:34

Re the post at 17.22

It would help if we knew exactly what the IFA was proposing, rather than someone's interpretation. The comments in the above post are now suggesting that the company (and not the individual) will take out the new borrowing, with security given over another property. Prima facie, the company should be entitled to relief for the interest, provided that the loan has been taken out for the purposes of the company's rental business.

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By jaffe123
10th Jun 2014 20:44

BKD - Maybe I worded it incorrectly - the individual will be taking out the loan against her main residence not the company

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By User deleted
10th Jun 2014 21:27

Which takes me right back to my earlier point

If the loan is in the individual's name, and the rental profits are taxed in the company, where do you/your IFA think the interest is going to be relieved and against what?

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By raybackler
18th Jun 2014 13:52

Rental to the company

Surely this could be structured so the limited company rents the property from the individual, such that there is sufficient income to offset the loan interest.

The limited company then is free to rent the property out at a higher rent to cover the costs incurred in repairs and renewals etc.  The profit is struck after declaring these costs and the rental paid to the individual.

This would save Corporation Tax and, if structured properly, give a zero or close to zero charge on the Self Assessment Tax Return.

There are restrictions on the level of loan, on which interest can be claimed for the rental business, but it is nothing to do with the Buy to Let Loan to Value percentage, which can vary by lender.  The key thing to establish is the Capital Account at the start of the rental business.  You can borrow up to this level and claim a tax deduction.

Extract from HMRC Example: Man buys London flat to live in for £150000 with an £80000 mortgage.  Later on he gets a job in Amsterdam, so he wants to start a property rental business in London to fund a personal flat purchase in Amsterdam.  Market value of London flat is £375000 at the time he started the property rental business and his mortgage increases to £205,000, so he can raise £125,000 for the personal flat purchase in Amsterdam for him to live in.  The capital account starts at £295000 for his new business (£375000 value less existing mortgage of £80000).  He withdrew £125000 of capital because of the additional mortgage and the capital account went down to £170000, and as it is not overdrawn it means all of the interest is allowable.

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