Income Tax Relief Restrictions for Residential Landlords

This change was announced last year but it is only now, when the final legislation has been passed, that we have the final guidance and full detail on exactly how landlords will be affected.

When the changes are fully in force, instead of landlords being able to declare their net income, after setting financing costs such as mortgage interest against their rental receipts, the starting point will be that income tax is payable on the rental income without taking any account of financing costs, but then allowance will be given for a “basic rate tax reduction”: a deduction equal to the basic rate (currently 20%) on the financing costs.

Before getting in to the mechanics of it, it is important to remember that the changes affect only individuals who own and let residential property so companies holding buy-to-let properties are not affected, and individuals who own commercial property and let it as a business are also not affected (don’t forget this includes properties used in a short-term holiday lettings business). On the other hand it is important to stress that the changes do affect UK-resident individuals who own property abroad and let it for income, and also affects non-UK residents who own property in this country.

Some individual buy-to-let landlords are “incorporating” (transferring their properties into a corporate structure) as a result of the changes, but this may not be the solution for everyone. It raises other issues on the taxation of dividends, etc. and should not be undertaken without taking careful advice.

The transition from the ability to get relief for 100% of financing costs and the new allowance to be able to claim 20% of finance costs against the tax liability is being phased in over four years, so the table of rates looks like this:

2017-8 75% of finance costs deductible 25% of basic rate tax deduction available
2018-9 50% of finance costs deductible 50% of basic rate tax deduction available
2019-20 25% of finance costs deductible 75% of basic rate tax deduction available
2020-21 0% of finance costs deductible 100% of basic rate tax deduction available

The “basic rate tax reduction” will normally be 20% of the financing costs, but, if lower, it is limited to 20% of the profits of the letting business (after taking account of any losses brought forward from earlier years) or 20% of the taxpayers adjusted total income (excluding investment income) in excess of the personal allowance.

An example may help. Suppose X is self employed, and had income in 2016-17 of £35,000 from his business but also owns a property let at £1,500 per month (£18,000 per year) with outgoings for maintenance, etc. of £2,000 in the year plus a mortgage on which interest of £8,000 is paid. Before the changes, his income is simply £43,000 (£35,000 plus the net income on the property of £8,000 after deducting the outgoings and mortgage interest). The first £11,000 is tax free, the next £32,000 is taxable at the Basic Rate so X will pay £6,400 in income tax.

After the changes, however, if the figures are the same for the 2020-21 year, X would get no deduction for the finance costs, so the starting point is income of £51,000 (£35,000 from self employment plus £16,000 from the property). Again, the first £11,000 is tax free and £6,400 is payable on the basic rate band, but there is also £8,000 in the higher rate band, taxable at 40%, for an additional tax liability of £3,200 so the starting point is income tax payable of £9,600 (£6,400 + £3,200). Against this, however, can be set the new relief. 20% of the £8,000 finance costs is £1,600, so this is set against the tax payable, making the final liability £8,000. If it were lower, only 20% of property profits or adjusted total income would be available but, in this case, both figures would be higher (20% of £16,000 = £3,200 and 20% of £40,000 = £8,000). So 20% of the finance costs can be off-set, but the bottom line is that X is still Paying £8,000 in income tax when he previously paid only £6,400 – £1,600 worse off!

If you have buy-to-let income and would like to know more about how you will be affected, just get in touch with us.

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