Can I offset interest on a remortgage against rental income?

Q I purchased a property in 1990 which I have been letting out after living in for a couple of years. The purchase price of the property was ?63,000.

Over that period of time the capital that I owe on the property has reduced to ?30,000.

Can I now remortgage the property back to the original amount and offset the interest payable against my rental income? I intend to use the money that I raise through the remortgage to pay off the mortgage in the property that I now live in.

DW

A You are right in thinking that you can offset the interest part of mortgage payments as an expense against rental income which has the effect of reducing the amount of rental income on which you pay tax.

Interest is allowable as a deduction when working out the profits of what the Inland Revenue refers to as your "rental business" provided it is incurred "wholly and exclusively for the purposes of the business".

I originally thought (wrongly) that the interest on your proposed increase to your mortgage would not qualify because the use you intend to put the cash to is purely personal.

However, according to little-known guidance published by the Inland Revenue for its staff and other tax practitioners, taking out a loan to fund a withdrawal of the capital you have put into your business - in your case, the property that used to be your home - comes under the heading of business purpose. And in this instance, what you choose to do with the cash is irrelevant.

But there are limits. You can set all the interest on the loan against rental income only if the total loan (your existing mortgage plus the increase you are proposing) is no greater than the profits earned by your rental business plus the value of the property at the time you started letting it out (and so it became a business asset).

The amount of interest you can set against rental income will be restricted if the loan your total borrowings exceed the profit-plus capital-invested figure.

You will find useful examples of how this works in practice in the guidance published by the at Inland Revenue.

· This answer updates inaccurate information originally given to the reader.