October 29th, 2012 / Insight posted in

Keeping tax perks on a refinancing

RB writes: My wife and I own an investment property in joint names that generates £50,000 a year. This is financed by a £500,000 bank loan on which interest is charged at 1.5% over base. This loan facility is about to expire and our bank has offered us a new loan at 3% over base – with a 1.75% arrangement fee. We have enough capital to repay the loan, but would it then be possible to refinance the property later to raise funds for other projects – and still deduct the interest from the rental income?

The increase in your financing costs is typical of those encountered by many property investors at the moment, writes Heather Powell, a partner in the property team at Kingston Smith LLP. However, you are in the fortunate position of having sufficient capital to repay your bank loan and the interest currently being earned on this money is lower than the interest you will be paying on a new loan.

You do not want to lose the ability to deduct the interest paid on the bank loan from your rental income because you will need to refinance the property eventually to fund the purchase of a home.

Repaying your bank loan now does not preclude you from claiming a deduction of interest on future borrowings secured on your investment property, as long as your future borrowings do not exceed the market value of the property at the time it was first let by you and the cost of any improvements made to it while you owned it.

By repaying the bank loan from personal resources you are injecting capital into your rental business. The tax rules allow the deduction of any interest payable on a future loan taken out to fund the withdrawal of this capital.