There have been numerous changes to the buy-to-let tax rules in the last year, and the trend is set to continue, with interest relief restricted from April 2017. Here we provide further information on the latest reforms, which could be unwelcome news for many residential landlords…
Under the existing rules, residential landlords can deduct all of their finance costs, such as mortgage interest, from their gross property income. However, starting from April 2017, relief for finance costs will be restricted to the basic rate of income tax. For the purposes of the restriction, finance costs include interest on mortgages, loans (including loans to buy furnishings) and overdrafts. Other costs that are affected include alternative finance returns, fees and any other incidental costs for getting or repaying mortgages and loans, and discounts, premiums and disguised interest.
The new rules only apply to individuals with residential property businesses. They do not apply to companies, landlords of commercial properties or furnished holiday lettings.
Timescale for the change
The change will be introduced gradually over a period of four years, as follows:
- In 2017/18, the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
- In 2018/19, the deduction will be restricted to 50% of finance costs, with the remaining 50% given as a basic rate tax reduction
- In 2019/20, the deduction will be restricted to 25% of finance costs, with the remaining 75% given as a basic rate tax reduction
- From 2020/21, all financing costs incurred by a landlord will be given as a basic rate tax reduction (currently 20%).
Calculating the reduction
The reduction will be calculated at the basic rate value of the lower of:
- Mortgage interest and finance costs not deducted from rental income in the tax year (this will be a proportion of finance costs for the transitional years) plus any finance costs brought forward
- Property profits less any losses brought forward
- Adjusted total income (after losses and reliefs, and excluding savings and dividends income) exceeding the personal allowance.
The changes are likely to result in an increased tax liability for many residential landlords, but there may also be wider implications to consider. For example, the new rules will increase gross income, which may push an individual into a higher tax band. This, in turn, could have an impact on their ability to claim Child Benefit, which is currently clawed back for those with adjusted net incomes over £50,000. Where this is the case, an individual might want to consider reducing their income, for example by increasing their pension contributions or making Gift Aid donations. However, it is essential to seek professional advice before taking any action.
For more information on the tax rules affecting residential landlords, please do contact us.