Most people assume that there has been no possibility of income tax relief for interest paid on their home mortgage since the full abolition of MIRAS, which allowed it, by Gordon Brown in 2000.
This is strictly true. But as with so many tax issues, all is not quite what it seems. It is actually possible, in certain circumstance, to use your mortgage to reduce your tax bill.
In simple terms, it is those with an active interest in a business or who acquire a property let on a commercial basis who might be able to achieve this….subject to their ability to rearrange their borrowings.
The trick is to reduce borrowings on a home (no interest tax relief) replacing it with borrowing obtained for some other “allowable” purpose.
Someone with a £50,000 mortgage at a 5% interest rate acting as above could, as a higher rate (40%) taxpayer, save £1,000 of tax each year. An “allowable purpose” is permitted to :
- Introduce capital to a partnership where you are a partner
- Buy shares or lend money to a trading company (controlled by the directors or by five or fewer people in which the individual either owns more than five per cent of the shares or works mainly for it).
- Acquire a buy-to-let property.
Let’s assume you have a £60,000 “credit balance” on your capital account in the partnership’s books and a home with an outstanding mortgage of £50,000.
You could, with the agreement of your colleagues, “convert” your mortgage into a loan to the partnership.
In practical term, this would involve withdrawing £50,000 from your partnership capital account to repay the mortgage in full. You might then borrow a similar sum from a bank or building society, probably secured against your home, to the partnership to replenish your capital requirement as a partner. Result: a personal tax bill reduced by up to £1,000 a year.
In the case of limited companies, if yours owes you money, consider taking it out to repay all or some of your mortgage. Borrow with a new loan to re-lend the money to the company with interest qualifying for income tax relief at your top rate.
It is these days possible to borrow money for a second property at interest rates not dis-similar to those available for your home.
Let’s look at Dr Smith, a 40% tax payer with a mortgage of £100,000 who inherits £200,000 all of which she decides to invest in a small buy-to-let flat. If this produces taxable rental income of, say, £7,500, she will receive £4,500 after tax
However, if she borrowed £100,000, despite not needing it, to buy the property it would “free up” £100,000 of her inheritance to redeem her home mortgage.
This could save Dr Smith £2,000 a year in tax (£100,000 at 5% interest at 40% tax saving) because the interest paid on the rental loan will be deductible from the income arising from the buy-to-let. Better yet, she has removed her tax inefficient home mortgage.
The lesson is clear: tax is not straightforward, and (within limits) there are still ways to make your mortgage work better for you. As with all things taxing, however, such arrangements are always open to challenge by HMRC so it’s vital they are handled with utmost care taking prior professional advice before “jumping in”.