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From Principal Private
Residence to Rental Property
Deirdre Donaghy, Supervisor Private Wealth
Services
Scenario
A married couple own a home with a mortgage of €100,000.
They plan to buy a new house with a mortgage of €200,000
and keep the original home to rent out as an investment
property.
They plan to increase the mortgage on the original
home to €200,000 and have just €100,000
mortgage on their new home and claim a deduction for
the interest paid on the additional €100,000
as a deduction against rental income. Is this possible
and what are the tax implications?
Unfortunately, no, it will not be possible to use
the interest paid on the additional €100,000
as a deduction against rental income.
Rental properties have become a much more attractive
investment in recent years, due in part to the re-introduction
of relief for mortgage interest paid on rental properties;
the continued capital growth of the property market;
and the relatively poor performance of equities and
pension funds in recent years.
Some taxpayers are now considering retaining their
old property to rent out when they trade up or down
to a new home. They may however be unaware that Revenue
legislation in relation to deductible rental expenses
is quite specific, and should take care to ensure
that the correct deductions are claimed.
The legislation in relation to interest states that
a deduction may be claimed for ‘interest on
borrowed money employed in the purchase, improvement
or repair of the premises.’
As such, interest on borrowings used for the purchase
of your new home, regardless of the fact that they
are secured on the rental property, will not qualify
for a deduction against your rental income.
Mortgage interest on the new home will of course qualify
for standard tax relief, but this relief is capped
at interest paid of €5,080 per year for a married
couple who are not first-time buyers. Some taxpayers
can now find themselves paying interest in excess
of the threshold on their private residence, and consequently
try to re-arrange their borrowings to get relief against
rental income.
The Revenue take quite a dim view of such maneuverings
however, and signaled their intention to be strict
in the enforcement of the interest provisions with
the introduction of new anti-avoidance legislation
in the 2003 Finance Act.
Previously, some taxpayers, had developed a scheme
in order to increase the interest deduction against
their low-mortgage rental property. The scheme involved
one spouse selling their interest to the other spouse,
who would take out a loan in order to fund the purchase.
The loan interest would be claimed as a rental deduction,
and the capital payment to the first spouse could
be used in the purchase of the new property.
The 2003 Finance Act brought in specific legislation
to close off this scheme, and relief is no longer
allowed in respect of loans taken out to acquire an
interest in a rental property from a spouse. The restriction
does not apply in the case of legal arrangements between
separated or divorced spouses.
The opportunities available to increase interest deductions
against rental income are therefore limited. It would
of course be possible to sell the original house,
and purchase a new rental property. Principal Private
Residence relief would be available against any capital
gain made on the disposal, provided the relevant conditions
were fulfilled. The bulk of the sales proceeds could
then be used against the purchase of the taxpayer’s
new home, leaving a larger mortgage on the newly purchased
rental property.
It is, however, unlikely that the costs associated
with such a plan would be justified in terms of the
potential tax savings generated by the interest deduction.
For taxpayers planning on holding just one rental
property, it would probably be better to leave the
current mortgage situation unchanged, and accept the
slight loss in interest relief on private home-loan
interest payments in excess of the annual limit.
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