Deducting interest payments from letting income

jennifernil

I have been going round in circles trying to find an answer to this, hopefully one of the tax experts on here can advise.......

My daughter owns a flat outright, having repaid the original mortgage (which was for £113k). She has lived there for 9 years, and it is in a very good area for letting easily. Predicted rental is in the region of £800-£900 pcm. The flat was purchased for £159k and is now valued at around £170k.

She is moving house soon, but plans to keep the flat to rent out, mainly as this is not a good time to sell quickly, but also as it will give her a modest amount of extra income. This is something she has been considering doing for a couple of years now.

She has found a few BTL mortgages that would easily allow her to release around £100k from the flat to use towards the purchase of the new house. The rental predicted would be over 50% higher than the mortgage repayments. She does realise there will also be significant other costs.

She has already secured a residential mortgage for the rest of the purchase price of the new house, and has enough other funds to meet legal and removal costs and various other additional expenses.

So my first question is......

Would the interest on this BTL type mortgage on the flat be able to be deducted from the rental income for tax purposes?



Realising that BTL motgage rates are higher than residential rates, and than rates paid to savers, and that arrangement fees are very high, I am considering whether I might offer to lend her the £100k at a rate that would benefit us both.

This would save the large arrangement fee, and give her greater flexibility should she wish to sell the flat in a few years time.

I would have a proper agreement drawn up and place a charge on the property to protect my interests.

So my second question is......

Would this "private mortgage" have the same standing in the eyes of HMRC as one from a bank for example?

And what proof does she need to give HMRC of the interest paid if she is able to deduct this for tax purposes?

The interest paid to me would of course be liable for tax as my income, but as my pension is small, I have plenty of unused personal allowance left to cover this, so this would not be a problem. All other savings income is from ISAs.

All advice most welcome!

jimmo

I feel used to seeing your Username on this forum and a lot of very sound advice you have given to others and am struggling how to pitch a reply.

Can I ask whether you can understand the accountancy and tax consequences of example 2 in this link?

http://www.hmrc.gov.uk/manuals/bimmanual/BIM45700.htm

jennifernil

Hello jimmo, I was hoping you might have the answer!

I do indeed understand the example in scenario 2, it is more or less what she is planning to do. In fact, I seem to remember reading that before, but I couldn't remember how I had come across it.

Based on that, it would seem her plan is OK.

What about if I lend her the money instead?

jennifernil

On further reflection, it seems to me that the source of the borrowed funds is not relevant, so our plan would be fine.

jennifernil

Jimmo.......would the rate of interest I charge her have any bearing on whether the loan interest is allowed as a deduction?

A poster on another forum has suggested that it would only be allowed if I charged a "commercial rate" , which he has defined as the rate I would charge a third party.

jimmo

Hello again Jenifernil.

Glad to see that helped.

With regard to you lending your daughter the money I am not aware of any special rules regarding the interest rate to be applied but the big problem with the HMRC website is that its virtually impossible to prove that a rule doesn’t exist. However common sense suggests that if you charge her more than you could achieve by depositing the money in a bank but less than she would have to pay for a BTL mortgage you are both winners. I just can’t see a problem.

Commercial reality does however crop up occasionally.

The 2 examples that spring to mind quickly are both concerned with losses.

One is in trading losses.

http://www.hmrc.gov.uk/manuals/bimmanual/BIM75705.htm

The other is in letting.

http://www.hmrc.gov.uk/manuals/pimmanual/PIM2220.htm

jennifernil

Thanks again. Hopefully we will both come out of the deal well! Certainly she will need to make a profit, so helping her avoid the huge arrangement fees that seem common these days will help.