MR C from Co Wicklow is a civil servant due to retire in three years time. He and his wife (they have no children) have invested in rental properties, one of which was purchased in 1972 and the other in 1992 for £85,000 (site cost £25,000, development cost £58,500, builder's profit £1,500) under Section 23 of the 1988 Finance Act and therefore subject to considerable tax reliefs. He has a mortgage of £60,000 on this house both properties are rented at £500 a month or £12,000 a year in total. His mortgage interest relief amounts to £4,327 a year. Mr C also has £40,000 invested with a credit union.

With retirement imminent, our reader wants to know "whether it would be financially sound to reduce the £60,000 mortgage by the £40,000 or would it be more beneficial to invest the money elsewhere?" He is also unsure whether his rental income of £12,000 is - all being deducted under Section 23 rules "or is it £7,673, the difference between £12,000 minus my mortgage interest relief of £4,327?" Finally, Mr C wants to know if he would be subject to Capital Gains Tax if he sold the house he bought in 1972.

Family Money contacted Sebastian Devlin of the Taxation Advice Bureau for answers to Mr C's questions, he supplied the following information:

Your reader's letter raises five queries - how is Section 23 relief calculated? How is it claimed? How is interest paid treated for tax purposes? How is credit union interest taxed? How is CGT calculated?

Section 23 relief is calculated by multiplying the purchase price by the builder/development cost and dividing the total by the sum of the site cost plus the builder/development cost. In this case purchase price = £85 Kx builder/ development cost £58.5 K = £4972.5 K / £25 K (site cost) + £58.5 K (builder development cost) = £59,550.

This £59,500 may be offset against your taxable rental income in year one or over a number of years depending on your individual circumstances - e.g. in your case if the full - £12,000 income was taxable this relief would be used up over approximately five years.

As for how interest paid is treated for tax purposes, it is not clear from the letter whether the £4,327 mortgage interest relief relates to the main residence or a rental property. If it does relate to the main residence mortgage interest may be claimed in the normal way against PAYE income and the full rental income could be set off against Section 23 relief. If it relates to a rental property it would be offset against the rental income from these properties and only £7,673 would be offset against Section 23 relief. The Section 23 relief in these circumstances would last approximately seven years (£59,550 divided by £7,673).

Capital Gains Tax on the 1972 property is payable on a taxable gain in excess of inflation. The base cost of the property is indexed by the Consumer Price Index before the taxable gain is calculated. CGT was first introduced on April 6th, 1974 so, the base cost of this property for CGT purposes will be the market value on that date.

If the property was valued at, say, £10,000 in 1974 the CGT would amount to £7,132. The table below contains a worked example calculating the CGT liability on the 1972 property.

Mr C asks about whether he should repay his mortgage with his Credit Union savings. (Interest and dividends received from a Credit Union are paid gross and are taxable.) Such a decision needs careful consideration taking into account cash flow requirements over the next few years, the level of tax free returns you could obtain on this money and his own risk profile.

The Taxation Advice Bureau, an independent fee based service can be contacted at (01) 676 8633.