What are the tax implications of refinancing an HMO property?

Refinancing a House in Multiple Occupation (HMO) property involves complex UK tax rules, primarily concerning the deductibility of mortgage interest and the treatment of any capital raised. Landlords must meticulously track the use of borrowed funds, as interest is generally only deductible against rental income if the money is used wholly and exclusively for property business purposes. Understanding current legislation, such as the restriction on mortgage interest relief (Section 24), is crucial to avoid unexpected tax liabilities.

Addressing what are the tax implications of refinancing an HMO property?

Refinancing a property—replacing an existing mortgage with a new one, often to secure a better rate or raise capital—is a common strategy for professional landlords operating Houses in Multiple Occupation (HMOs). However, navigating the tax landscape for HMO refinancing requires careful attention, as HMRC scrutinises the purpose of the debt.

The primary tax implications fall into two categories: Income Tax (related to rental profits) and potential Capital Gains Tax (CGT, though usually less immediately impacted by refinancing). For UK landlords, understanding the rules around allowable expenses, particularly mortgage interest, is paramount when dealing with refinanced debt.

Mortgage Interest Relief Restrictions (Section 24)

The biggest change to HMO financing tax relief in recent years is the implementation of Section 24 of the Finance (No. 2) Act 2015, which fully phased out the ability for individual landlords to deduct mortgage interest costs directly from rental income.

Since the 2020-2021 tax year, instead of deducting interest as an expense, individual landlords receive a basic rate tax reduction (credit) equivalent to 20% of their finance costs. This rule applies equally to original mortgages and refinanced mortgages.

How Refinancing Impacts the 20% Tax Credit

When you refinance, you are simply replacing one set of finance costs with another. The amount of the loan that originally related to the purchase price of the property will typically continue to qualify for the 20% tax credit, provided the HMO remains a legitimate rental business.

This relief is complex, especially for high-rate taxpayers, as the full rental income is taxed first, and the tax credit is applied later. Therefore, while refinancing might save you money on interest rates, it doesn’t change the underlying structure of how that interest is treated for tax purposes.

• Old system (pre-2020): Interest was fully deducted from rental income, reducing taxable profit.
• Current system: Interest is not deducted. Instead, you get a tax credit equal to 20% of the interest costs, regardless of your personal income tax bracket.

Tax Treatment of Capital Raising During HMO Refinancing

Many landlords refinance their HMOs not just for a better rate, but to raise additional capital, perhaps to fund another property deposit, pay for major repairs, or improve the HMO itself. The tax implication of this raised capital is governed by the ‘wholly and exclusively’ rule.

Raising Capital for Property Business Purposes

If the new, larger mortgage includes capital raised specifically for the HMO business—for example, to fund an extension, a kitchen upgrade, or necessary structural repairs—the interest on that additional sum is typically treated as an allowable finance cost, qualifying for the 20% tax credit.

It is essential to keep precise records (invoices, bank statements) showing that the borrowed money was immediately and directly injected into the property business.

Raising Capital for Personal Use

If you raise capital from the HMO and use it for non-business purposes—such as buying a personal car, funding a holiday, or purchasing another asset not related to the property business—the interest related to that specific portion of the loan is not tax-deductible or eligible for the 20% tax credit.

HMRC requires landlords to trace the use of the funds. If a £50,000 capital raise is obtained, and £20,000 goes on new property acquisition (business use) and £30,000 is used for personal expenses, only the interest relating to the £20,000 is potentially tax-relievable.

The general rule is that you cannot claim tax relief on interest for a loan amount that exceeds the capital value of the property when it was first brought into the rental business, unless the excess capital was reinvested wholly for business purposes.

Stamp Duty Land Tax (SDLT) and Refinancing

In most instances, standard refinancing of an HMO (where the legal ownership structure remains the same) does not trigger a new Stamp Duty Land Tax (SDLT) liability. SDLT is primarily a tax on the acquisition of a property or a change in ownership.

However, SDLT could potentially apply if the refinancing involves a restructuring of ownership, such as transferring the HMO from personal names into a Limited Company (often called incorporation). This process is treated as a sale and purchase, and therefore attracts SDLT, often including the 3% surcharge for additional properties. This is a highly complex area, and professional tax advice is mandatory before attempting incorporation or significant structural changes.

Record Keeping, Credit, and Seeking Expert Advice

Accurate and robust record-keeping is the backbone of successful property tax management, particularly when dealing with complex HMO refinancing. HMRC requires landlords to keep all documentation for up to six years after the relevant tax year. This includes all mortgage statements, solicitor completion statements, evidence tracing the use of capital, and interest certificates.

When applying for refinancing, your credit history plays a vital role in determining eligibility and the interest rates offered. Lenders will thoroughly review your credit profile.

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Because the rules governing HMOs, Section 24, and the tracing of borrowed funds are intricate, it is highly recommended that landlords seek tailored professional advice from a qualified UK accountant or tax specialist who understands buy-to-let and HMO tax law.

For official guidance on UK property rental income, you should always consult the resources provided directly by HMRC. You can find detailed information on allowable deductions and property income tax rules on the GOV.UK website.

People also asked

Does the interest on a buy-to-let mortgage increase my capital gains tax liability?

No, mortgage interest itself does not increase your Capital Gains Tax (CGT) liability. CGT is calculated based on the difference between the sale price and the cost of acquisition (purchase price plus certain allowable costs like Stamp Duty and capital improvements). Mortgage interest is an income expense, not a capital expense, and is therefore dealt with under Income Tax rules.

Can I claim refinancing arrangement fees as an allowable expense?

Generally, fees associated with arranging the mortgage or refinancing—such as lender arrangement fees, broker fees, and legal fees directly related to the loan—are considered finance costs. These costs are subject to the same Section 24 restrictions, meaning they qualify for the 20% tax credit rather than being deducted directly from rental income.

What if I refinance my HMO into a Limited Company structure?

Refinancing into a Limited Company structure (incorporation) is a significant tax event. The company can typically deduct all finance costs (mortgage interest) as a business expense, making it beneficial for high-rate taxpayers. However, this process usually triggers SDLT and potential CGT upon transfer from personal ownership, requiring careful planning and professional valuation.

If I use the equity release from refinancing for improvements, do I need to keep separate accounts?

Yes, strict record-keeping is vital. You must be able to demonstrate to HMRC that the new funds were used exclusively for legitimate capital improvements (e.g., building an extra bedroom) or necessary revenue repairs (e.g., replacing a boiler). Commingling funds or failing to trace the expenses could result in the corresponding interest being disallowed for tax relief.

Is insurance on my HMO tax-deductible?

Yes, standard costs necessary for running the rental business, such as landlord insurance, repairs, maintenance, and HMO licence fees, remain fully deductible against rental income before calculating profit. These costs are treated separately from mortgage interest, which falls under the Section 24 tax credit rules.

In summary, while refinancing an HMO is a powerful tool for portfolio management, landlords must prioritise compliance and ensure they have a clear audit trail for all borrowed capital. The difference between allowable and non-allowable interest can significantly impact the overall profitability of the investment, making specialist advice invaluable.