Changes to tax relief on finance costs for residential landlords

From April 2017, HMRC are phasing in a restriction on the tax relief that landlords of residential properties get for finance costs. The amount of Income Tax relief landlords will be able to get on residential property finance costs will be restricted to the basic rate of tax (currently 20%).

Who will be affected?
You will be affected if you are a:
* UK resident individual that lets residential properties in the UK or overseas
* Non-UK resident individual that lets residential properties in the UK
* Individual who let such properties in partnership
* Trustee or beneficiary of trusts liable for Income Tax on property profits

What finance costs will be restricted?
Finance costs that will be restricted include interest on:
* Mortgages
* Loans – including loans to buy furnishings
* Overdrafts
* Fees and any other incidental costs for getting or repaying mortgages/loans
* Discounts, premiums and disguised interest

If you take out a loan for both residential and commercial properties or for a self-employed trade and residential property then you will need to use a reasonable apportionment of the interest to work out your finance costs for the residential property.

How is it being phased in?
The restriction is being phased in from 06 April 2017 and will be fully implemented from 06 April 2020.

During this transitional period you will still be able to deduct some of the finance costs when you are working out your taxable rental profits. However from 2017 – 2020 these deductions will be gradually withdrawn and replaced with a basic rate relief tax reduction.This is shown in the diagram below:

Tax Year         % of finance costs deductible from rental income    % of basic rate tax from rental income

2017 – 2018                                       75%                                                              25%

2018 – 2019                                       50%                                                             50%

2019 – 2020                                      25%                                                             75%

2020 – 2021                                        0%                                                            100%

Example using 2016-17 tax rates
An individual with rental income of £52,000, mortgage interest of £20,000 and allowable expenses of £9,000

Before the restriction (2016 – 2017), this individual had rental profits of £23,000, had 20% tax to pay on £12,000 of these profits therefore having a tax bill of £2,400.

After the restriction (2020 – 2021), this individual would have rental profits of £43,000 (mortgage interest not deductible), therefore paying 20% on £32,000 leaving tax due of £6,400. However due to the new tax reduction, 20% of the finance costs – £4,000 can be deducted from the £6,400 leaving a final tax bill of £2,400 due.

How do I calculate the tax reduction?
The tax reduction is calculated as 20% of the lower of:
* Finance costs (100% of £20,000) = £20,000
o These are finance costs which aren’t deducted from the rental income in the tax year plus any finance costs brought forward from previous years after the transitional period has ended
* Property Profits = £43,000
o This is the rental profits in the tax year after using any brought forward losses and before the personal allowance
* Adjusted total income exceeding the personal allowance = £32,000
o This is the income (after losses, reliefs, excluding savings and dividends income) that exceeds your personal allowance.

Emer McAleer