It is now only six months until the changes to tax relief start to be phased in. Here is a quick refresher on the impact of the new finance costs restrictions.
What’s changed? In a nutshell, the tax relief that landlords of residential properties were able to claim for finance costs will be restricted to the basic rate of income tax. These changes will be phased in from April 2017.
Who does this affect? Landlords that let residential properties as an individual in a partnership or trust and also non-UK resident individual that lets residential properties in the UK.
Who is exempt from the changes? The following won’t be affected by the introduction of the finance cost restriction:
UK resident companies
non-UK resident companies
landlords of furnished holiday lettings.
The above will continue to receive relief for interest and other finance costs in the usual way.
How do the restrictions work? The amount of income tax relief landlords can get on residential property finance costs will be restricted to the basic rate of tax. The finance costs referred to above that will be restricted include interest on:
loans – including loans to buy furnishings
Other costs affected are:
alternative finance returns
fees and any other incidental costs for getting or repaying mortgages and loans
discounts, premiums and disguised interest.
The reduction is the basic rate value (currently 20%) of the lower of:
finance costs – 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 – the profits of the property business in the tax year (after using any brought forward losses)
adjusted total income – the income (after losses and reliefs, and excluding savings and dividends income) that exceeds your personal allowance
where the loan is for a dual purpose, say for both residential and commercial properties, the interest will need to be apportioned to work out the finance costs for the residential properties as only these costs are restricted. This same approach applies where the loan was partly for a self-employed trade and partly for residential property
the tax reduction can’t be used to create a tax refund
if the basic rate tax reduction is calculated using the ‘property profits’ or ‘adjusted total income’ then the difference between that figure and ‘finance costs’ is carried forward to calculate the basic rate tax reduction in the following years.
How does the phasing in work? The restriction will be phased in gradually from 6 April 2017 and will be fully in place from 6 April 2020.
Some of your finance costs can still be deducted during the transition period. These deductions will be gradually withdrawn and replaced with a basic rate relief tax reduction.
A proportion of the finance costs will be used to work out the property profits and use the remainder to work out the basic rate tax deduction:
Percentage of finance costs deductible from rental income
Percentage of basic rate tax reduction
2017 to 2018
2018 to 2019
2019 to 2020
2020 to 2021
The calculations using the new measures can be quite complicated so we recommend that members work through the examples that HMRC has published. There are three case studies which illustrate both the phasing in and the overall effects of the restrictions before and after they are operated. They use the following simplified figures: