Letting a cottage opens doors to tax clawbacks: You need to plan carefully to get the full benefit, says Mary Wilson

LETTING a second home can cut your tax bill, but only if you go about it in the right way.

David Bedford, senior partner of Bedford Country Property Agents, near Newmarket in Suffolk, found out too late that he had missed out on a valuable benefit.

'When I sold my original estate agency business some years ago, my wife and I bought four holiday cottages. Because I was flush with money at the time, we bought the cottages outright. I bought one, and my wife the other three,' Mr Bedford explained.

'Later I wanted to borrow some money against the properties and presumed I would be able to offset the loan interest against the profits from the property lets. But I discovered, to my cost, that you can't do it retrospectively. If it had been within a month or two, that would probably have been alright, but this was a couple of years later.'

What the Bedfords can offset against tax are all the running costs for their cottages, such as council tax and management charges.

'What I save in tax means we can afford to pay a gardener,' Mr Bedford chuckled.

'I give each new tenant a welcome pack - orange juice, cornflakes, that sort of thing - and that goes against the income too.'

Other tax implications are that, as with any business, if he sells and buys some more homes to let, he can roll over any capital gains tax due from one to the other. In other words, there would be no CGT bill to pay until he wound up his letting business.

Even better, from his point of view, is the rule which allows someone over 55 to sell property without having to pay capital gains tax up to pounds 150,000.

The Bedfords would like to sell now, but are sensibly waiting a year until Mrs Bedford turns 55, when she will be able to claim the retirement relief: over pounds 150,000 and up to pounds 450,000 only half is taxable, and you only pay full capital gains tax over pounds 600,000.

There are strict criteria, whuch must be fulfilled, about letting a second home if the full tax advantages are to be taken.

The property has to be offered for rent for at least 140 days a year and let for a minimum of 70 days. It must be furnished and it must be let on a commercial basis, not just cheaply to family or friends.

You can offset against profits all the interest paid on the loan borrowed for either purchase or improvement of the property, as long as it is borrowed at the outset.

The accountancy firm BDO Binder Hamlyn has produced a pocket booklet, Live and Let, stating the tax position for holiday and residential lettings.

The Inland Revenue has rumbled the fact that some people are borrowing more than is needed, so they can put up a negative income. But if the loan is genuine, and the interest more than the profit, this can be offset against other income, as shown in the following example:

Rental income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . pounds 7,500

Less running costs . . . . . . . . . . . . . . . . . . . . . . . . . . . .pounds 4,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .pounds 3,500

Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .pounds 5,000

Less net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .pounds 3,500

Loss to be offset . . . . . . . . . . . . . . . . . . . . . . . . . . . . .pounds 1,500

against other income

The booklet is available from any office of Binder Hamlyn or from its publications department on 071-489 9000.

(Photograph omitted)