Existing property as guarantor

jamesd

The correct answer here is to get personal advice from an accountant experienced in this area so it can be done properly so it qualifies for the deduction. It's entirely possible to get it wrong and lose it.

holly_hobby

jamesd wrote: »

The correct answer here is to get personal advice from an accountant experienced in this area so it can be done properly so it qualifies for the deduction. It's entirely possible to get it wrong and lose it.

Absolutely ... HMRC or an accountant should they employ one, will very quickly confirm what constitues as a business expense (as discussed), and in this case, the correct procedure for lawfull mortgage interest offsetting, in respect of a lettings business and the funding of a primary residence.

H

jamesd

The difference is that HMRC will say what can't be done, while an experienced and good accountant will say how to do it. And be on the hook for professional liability if they get it wrong.

holly_hobby

Well if HMRC say what isn't a business expense (i.e - can't be done), isn't that the object of the exercise in the first place ?

However, although an accountant incurs an expense, it should also be a permitted deduction if used in connection with the business itself (advice, preparation of annual SA, books or however the OP wants to present their annual submission to HMRC).

SA105 gives guidance on permitted deductions.

Also, some further general guidance notes for them ...

http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/TaxOnPropertyAndRentalIncome/DG_10014027

Anyways, I feel the OP now has sufficient info to go forward with this, so I'll bid farewell on this one until they shout for more help !

H

jamesd

Not the object, the object is to say how to do it in a way that HMRC accepts, not one that it doesn't accept. As both Wh05apk and Meeper noted, their clients routinely do transactions of this general nature. It's just a case of doing it properly.

One way to structure it is to transfer the existing property to the business then take out a fees-free mortgage and withdraw some of the capital that was just transferred into the business. One minute later, refinance that mortgage with a residential mortgage secured on the newly acquired property at a lower interest rate than the one minute mortgage. There's then a clear business gain from the lower interest rate. This sort of approach may well be an excess of caution but some accountants like an excess of caution.

But nobody should just do that. There's enough money at stake to make it worth getting the professional service of an accountant and their liability insurance.

More generally, it's a question of finding the professionals who say "you can't do it that way, do it this way instead" rather than the ones who stop at saying "you can't do that".

holly_hobby

We have been through this a millon times .... the only way to have the new property accepted as a business expense, and "transferred into the business" as a commercial asset, is to LET it ... (the OP actually having to buy it first !!). Further to which, should this be the case, it would mean that it is no longer the primary residence of the OP, which is the whole object of them purchasing it in the first place !!

It must be understood - the OP fully intends to reside in the new property (with no part of it commercially let).

Unless of course, as you suggested, the OP post purchase subsequently transfers it to the business, only acheived by its declared transfer from private residence to let status, but they actually continue to live in it as their PR after changing mortgages. Actually the source of mortgage either specific BTL or residential and swapping between the 2 (with a minimum period of 6 months between a change of lenders in any event), is irrelevant for tax purposes. Should the OP proceed on this basis, this would obviously be a fraudulent submission (as the property is not let), notwithstanding the ramifications of any mortgage interest relief which would also be fraudulently claimed if included in their annual submission. As any mge secured on their private residence, even if it were a BTL mortgage, is NOT an associated business expense but a personal one. And obviously not a procedure any accountant or professional could/would advise upon.

Similarly, if the property forms part of the "business" by actually being let, with the mortgage being offset as a permitted deduction - BUT then subsequently ceases to be let, changing its basis to a private residence of the individual - the propety at that point is effectively removed from business, as it is no longer let and clearly thereby no longer forms part of the lettings business being operated by the individual, so there are no business deductable expenses from that point (of course if it re-enters let at a later time, it then also re-enters the business, which will be the same for any properties owned by the individual)

So the transferring in of the property to the lettings business, by apparently purchasing it with a BTL mortgage (wrongly stating and inferring it is to be commercially let), then post completion simply changing the type of mortgage to a residential, and the OP simply to reside, would still not achieve the desired tax efficiency of mortgage offsetting - as the property once utilised as the OPs residence, and not let,will immediately remove it from the "business", it thereby becoming a personal asset and expense, and clearly not a business liability.

SO, a much simplier way to achieve tax efficiency, would be to remortgage the unencumbered (to be) let property, and use the released equity (classed as a cap withdrawal & a business expense so deductable) to purchase the primary residence. THAT mortgage interest would be a lawfully permitted deduction - as prev discussed at length.

I can't explain it any simplier, or put in any plainer language - seeking a morgage on a primary residence is not a permitted business expense (referring to interest element), but clearly a personal one, and it is therefore not a permitted deduction against rental income derived from the business (i.e other let properties held by the individual).

But as you say, and as in all cases, its best we leave technical or messy tax structuring to a qualified accountant or tax advisor.

H

jamesd

You appear to have misunderstood my post, so I've added a word in italics to clarify that the initial mortgage is taken out on the current property, which is to be let, not the new one.

holly_hobby wrote: »

seeking a morgage on a primary residence is not a permitted business expense (referring to interest element), but clearly a personal one, and it is therefore not a permitted deduction against rental income derived from the business (i.e other let properties held by the individual).

That's an inaccurate statement of the law and it's a transaction that's routinely carried out by large numbers of BTL landlords and other small business owners.

It seems that you're just not aware of the law that applies here and aren't going to accept it without specific HMRC references, so here they are.

If you don't believe that a business owner is entitled to use a loan to take capital out of a business, have a read of BIM45700:

"Example 2

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.

The opening balance sheet of his rental business shows:
Mortgage £80,000 Property at market value £375,000
Capital account £295,000

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 balance sheet at the end of Year 1 shows:
Mortgage £205,000 Property at market value £375,000
Capital account B/F £295,000
Less Drawings £125,000
C/F £170,000

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."

Note specifically the words I've highlighted in bold, the withdrawing of capital from a business property at the time it's transferred to a business to release funds for a purchase of a personal residence in Rotterdam and the explicit statement from HMRC that the interest is deductible as a business expense.

Now, on the matter of security, have a read of BIM45685:

"BIM45685 - Specific deductions - interest: Security for the funds

The security for borrowed funds does not determine the use of those funds. It is very common in small businesses for loans to be secured on the proprietor’s home, because that is the only substantial owned asset. This is not relevant to the consideration of the use of the funds borrowed. ...

Example

Mr Y has been driving an HGV for several years. He gets the opportunity to buy a nearly new vehicle for £25,000 if he can put down a deposit of £5,000. His home mortgage building society lets him borrow that money as he has equity of £20,000 in his house. The loan is secured on his house. This does not prevent the interest on the loan of £5,000 being accepted as incurred wholly and exclusively for business purposes, since the loan has been used to fund the acquisition of a business asset. The security is not relevant."

As HMRC clearly says, it's completely fine to deduct interest paid on a mortgage secured on residential property when the portion of the mortgage for which the interest is being deducted has been used for a business purpose.

However, it's not as safe as it could be to directly use a mortgage on the new residential property to reduce the capital entering the BTL business because HMRC could become confused about the purpose and think that the purpose is to buy the residential property, not to limit how much capital is transferred into the business. There have been some specific cases covering this and it's unwise to do it in a single step as a result of those decisions. This is a matter that personal advice from an accountant should be taken on.

holly_hobby

Oh James ...

jamesd wrote: »

If you don't believe that a business owner is entitled to use a loan to take capital out of a business

No, that is the complete opposite to what I have already said several times - please READ my comments regarding withdrawal or injection of capital into a business, and how loans in relation to this are permitted deductions..

But it appears you are mis-understanding both the situation we have and HMRC regs.

The OP does not yet own the property, and when they do, it will be a private residence and not enter the business by being let or acting as a source of investment into the business via equity release (although this may of course change in the future).

Therefore, when it is purchased, and whilst it remains the individuals private residence (with no financial relationship to the business), it does not form part of the business, and it is impossible that any loan on it (unless sourcing investment into the business), may be declared as a permitted business expense as it is NOT AN ASSOCIATED BUSINESS EXPENSE as previously discussed.

For the mge on the new property to achieve tax deductable status, the property would need to be actually let to enter the business OR source investment into the business (with relief limited to the amount directly utilised as the injection), to become a justified loan interest expense of the business. At this point the OP is only purchasing the property, which is to be the private res - so its initial mortgage is not a business investment, nor is it for a let property - so it is not a permitted deduction at this point.

jamesd wrote: »

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.

I've already said this numerous times ... the property can not form part of the business upon purchase, as it will NOT be let. Accordingly, it is also not an existing asset being used to fund a commercial investment (via a secured loan or otherwise) - it will be from outset, and remain the OPs private residence - with no commercial aspect to it.

However, your quotes from HMRC would be entirely appropriate if the OP was to REMORTGAGE THE CURRENT PROPERTY (WHICH IS TO BE LET AND TO BECOME THE 'BUSINESS, in order to FACILITATE THE PURCHASE OF THEIR PRIVATE RESIDENCE.

Indeed, it is such similar scenerios that the HMRC examples you give are based - clearly defining how and when a property is classed as entering or creating the business, and how the value at conversion (or purchase) affects the amount of future equity release which is classified as a permitted deduction against business income.

jamesd wrote: »

The security for borrowed funds does not determine the use of those funds. It is very common in small businesses for loans to be secured on the proprietor’s home

Yes - again at the risk of repeating myself, I have already said that a loan on a residential property, used as a capital injection into a business, is a fully permittable deduction under HMRC regs.

The business in this case is the property(ies) that the OP will be letting, not the one they are about to purchase, and to be used as their private residence - which is where the confusion appears to be coming from.

Just as capital withdrawal out of the business via a loan (secured or not) is again a fully permitted deduction against business income, REGARDLESS as to what the released funds are actually used for (whether it be for business or personal use).

The HMRC examples, and stance on this, are already familiar to me both from my personal BTL management and also professionally (having posted them myself in responses to previous similar threads on the board), but thanks for sourcing them and posting them for the ref of others.

Sure the OP has sufficient info to proceed, so would really like to conclude on this now - and await any feedback from them.

Holly

jamesd

Do you agree that once there is a mortgage on the let property that mortgage can be replaced by one on the new residential property? That is, that BIM45685 applies to replacing a mortgage secured on the let property with a lower interest rate one secured on the residential property?

Oneday77

I must admit, I didn't think it could all be so complicated. We have never done anything like this. At the moment we are just regular worker drones with no business experience. The option to let our flat was something we wanted to explore as the market is so flat just now. Admittedly where we live properties are still selling pretty well.
This may take a while but I will look back in when we have made a decision and explored all our avenues. Again thank you all for the debate and advice