As you may be aware, there have been significant changes announced with regards to the rules for those taxpayers with residential buy to let properties. One of these is how loan interest is utilised as an expense against rental income.
For the years up to the 2016/17 tax year, in order to arrive at a figure for taxable rental profit, allowable expenses were deducted from the amount of rental income due for the period.
These expenses have historically included:
Rents, rates, utilities and insurance
Repairs and maintenance
Finance costs, including mortgage interest
Legal and professional fees – e.g. agent’s fees
Services supplied to your tenants, e.g. gardening, cleaning
For a large number of landlords, the main expenses incurred on a rental property, which would usually reduce the profit subject to tax, are mortgage interest and agent’s fees.
However, the relief available in respect of the mortgage interest will change with effect from 6 April 2017. From this date, HMRC will be phasing in measures to reduce the relief that is given for this cost, and the amount of interest that can be deducted as an expense.
The ultimate result will be that, by the tax year 2020/21, finance costs (mortgage interest) will no longer be an allowable deduction when calculating rental profits. Rental profits will be calculated by ascertaining the rental income due for the year and deducting all allowable expenses, other than finance costs. The tax due on the rental profits will then be calculated at the relevant rate of tax. Relief for the finance costs will be taken into account by way of a deduction from the tax liability calculated, of 20% of the finance costs incurred (however this will be restricted if the profits calculated are lower than the interest charged).
This change will have the biggest impact on landlords who are higher rate and additional rate taxpayers, with a significant amount of borrowing against their rental properties. Whereas previously, by deducting finance costs to arrive at the net rental income subject to tax, each individual was effectively receiving tax relief at their marginal rate, relief will now be restricted to the basic rate of 20%. As a result, this new treatment could result in a higher taxable profit, and therefore an increased tax liability.
Basic rate taxpayers should also be aware, that they too could be significantly affected by these rules. By removing the deduction for finance costs from the calculation of rental profits, their total taxable income will be inflated, which could result in them exceeding the basic rate threshold and actually being charged to tax at the higher rate.
The phasing of the changes will take effect as follows:
Year | Loan interest deductible from rental profits | Amount of loan interest subject to new 20% relief
2016/17 | 100% | 0%
2017/18 | 75% | 25%
2018/19 | 50% | 50%
2019/20 | 25% | 75%
2020/21 | 0% | 100%
It is advisable to ensure that you are aware of these changes and how they may affect your tax position. It may be necessary to consider the options available if you are adversely affected.
Please get in touch with your usual Old Mill contact to confirm your position and explore any potential options.
Liz Kinder ATT
Direct: 01935 709306
Office: 01935 426181
Click below to download the Spring Summer 2017 Old Mill Westcountry Business News.