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Most tax tricks seem too good to be true or don’t deliver the promised goods, but here’s one that works and lets property investors take money locked up in the value of their properties to spend however they want.
Property people can even take loans against their rentals to pay down the mortgage on their homes while setting off mortgage interest tax relief against letting business profits.
And in these times of high mortgage rates and the spiralling cost of living, reducing tax bills is one way to ease the financial strain on landlords.
Usually, interest payable on mortgages or other loans raising money for a property business is an allowable expense when calculating rental profits regardless of the property the debt is secured against.
However, the money raised must be used for a business purpose, such as buying land or property to rent out or to fund refurbishment.
But believe it or not, HMRC allows a little-known exception - interest paid by a letting business on borrowed money to repay an investor.
The technical stuff is in the HMRC Business Income Manual (BIM) at BIM45700. The manual is HMRC’s interpretation of the law published as guidance for tax inspectors. The section deals with Section 34 of the Income Tax (Trading and Other Income) Act 2005.
Investors can take the tax-free cash in four simple steps, provided they own and have equity in the property.
For example, an investor owns a buy-to-let home worth £300,000 with a £150,000 mortgage. The difference between the value and mortgage is £150,000 or 50% equity.
The strategy applies to self-owned buy-to-lets in the UK or Europe, shared houses and holiday lets.
The loophole does not work for corporate letting property.
Here are the steps:
The money raised does not have to come from a mortgage - any other form of credit will do, like an overdraft, business credit card or bridging finance.
The opportunity to draw tax-free cash from a property business is created when a letting property is introduced.
The introduction is when a property is bought or converted to a rental by changing the use of another property. The latter occurs when someone moves out of their home and changes the use to a buy-to-let or holiday let, for example.
The deposit put into the deal by the buyer is their investment in the business. In the example above, that £150,000 equity is the asset's value.
That equity belongs to the investor; they are entitled to ask for it back, and the business can borrow the money to repay them as an allowable expense.
Because the landlord has already paid tax on the investment, there’s no double jeopardy, so no income tax is due when the money is repaid.
No capital gains tax is due because no disposal is involved.
Working out how much your property business owes you involves record-keeping from the first day of owning a property.
Keep a separate record for each rental and a consolidated account on paper or a spreadsheet.
This is how to do it when buying a flat valued at £125,000 with a £75,000 mortgage:
Transaction | Debit | Credit |
Purchase price | £125,000 |
|
Mortgage @ 60% LTV |
| £75,000 |
Investor input |
| £50,000 |
| £125,000 | £125,000 |
The account shows the property was bought for £125,000 with a £75,000 mortgage and £50,000 cash deposit from the investor.
Some years later, the property value appreciates. Then, the investor decides to remove some equity from the property with a remortgage.
Transaction | Debit | Credit |
Value | £180,000 |
|
Mortgage @ 60% LTV |
| £108,000 |
Withdrawn investor funds |
| £33,000 |
Remaining equity |
| £39,000 |
| £180,000 | £180,000 |
The investor remortgages at 60 per cent LTV, taking £33,000 in tax-free cash while leaving £39,000 equity in the property.
The investor has £17,000 more to draw as tax-free cash (£50,000-£33,000).