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Dear Barry
Impact of tax relief changes on landlords
3rd February 2017
Industry Information
Back in 2015, the government announced restrictions on tax relief for residential landlords’ finance costs.
Seeing 2017 on the calendar seems to have woken many people up to the fact that these changes take effect this April! Many still aren’t sure exactly what will happen and how it will impact them.
In reality, although it’s the latest in what may feel like a campaign of anti-property investor legislation, the government estimates that 82% of property investors won’t have any additional tax to pay because total income, without a deduction for finance costs, will not exceed the higher rate threshold.
Basically, most property investors won't see their total income pushed into a higher tax bracket, despite the new rules.
Let’s break it down:
Tax relief for finance costs will be reduced to the basic rate of income tax (currently 20%).
Instead of deducting all finance costs from your rental income, you will deduct the basic rate of income tax from the lower of:
The changes will be phased in, beginning April 2017.
The best way to demonstrate the changes is by illustrating some examples. For the sake of these examples, we are using the 2016 – 2017 basic income tax rate (20%) and personal allowances:
Before restriction (2016 to 2017)
Property income calculation:
Rental income = £55,000
Finance costs = - £22,000
Other allowable expenses = - £10,000
Property profits = £23,000
Total income = £23,000
Income Tax calculation:
First £11,000 of income (up to personal allowance) x 0% = £0
Next £12,000 of income (up to basic rate tax allowance) x 20% = £2,400
£0 income x 40% (higher rate tax threshold) = £0
Final Income Tax = £2,400
After restriction (2020 to 2021 - 100% of finance costs now eliminated from business expenses)
Property income calculation:
Rental income = £55,000
Finance costs (£22,000) = Nil deduction
Other allowable expenses = - £10,000
Property profits = £45,000
Total income = £45,000
Income Tax calculation:
£11,000 x 0% = £0
£34,000 x 20% = £6,800
£0 x 40% = £0
Less 20% for finance costs (£22,000 x 20%)= -£4,400
Final Income Tax = £2,400
The tax reduction is calculated as 20% of the lower of:
- Finance costs (100% of £22,000) = £22,000
- Property profits = £45,000
- Adjusted total income (exceeding Personal Allowance) = £34,000
The lowest amount is finance costs, so £22,000 x 20% = £4,400 tax reduction.
To demonstrate how your tax bill could go up, let’s look at Amanda.
Before restriction (2016 to 2017)
Self-employment income = £32,000
Property income calculation:
Rental income = £15,000
Finance costs = - £5,000
Other allowable expenses = - £1,000
Property profits = £9,000
Total income = £41,000
Income Tax calculation:
£11,000 x 0% = £0
£30,000 x 20% = £6000
£0 x 40% = £0
Final Income Tax = £6,000
After restriction (2020 to 2021 - when tax relief has been reduced by 100%)
Self-employment income = £32,000
Property income calculation:
Rental income = £15,000
Finance costs (£5,000) = nil deduction
Other allowable expenses = - £1,000
Property profits = £14,000
Total income = £46,000
Income Tax calculation:
£11,000 x 0% = £0
£32,000 x 20% = £6,400
£3,000 x 40% = £1,200
Less 20% tax reduction for finance costs (£5,000 x 20%)= -£1,000
Final Income Tax = £6,600
The tax reduction is calculated as 20% of the lower of:
- finance costs (100% of £5,000) = £5,000
- property profits = £16,000
- adjusted total income (exceeding Personal Allowance) = £35,000
The lowest amount is finance costs, so £5,000 x 20% = £1,000 tax reduction.
Amanda becomes a higher rate taxpayer because of the change, as her total income now exceeds the higher rate threshold of £43,000. Amanda has an additional £200 tax to pay.
Your mortgage payments will still be deductible; it’s the cost of any finance you now have to leave out of your tax return.
So finance costs include:
The government’s official advice is to use a ‘reasonable apportionment’ of the interest to separate out the costs of finance for the residential properties.
The restriction only applies to the finance cost of the residential property. What does that mean in real terms?
Simple example: let's say you have a mortgage that covers property you let to both residential and commercial tenants (eg you let out a shop AND the flat above it).
Get your accountant or friendly local property expert to help you work out what percentage of the mortgage applies to the flat. That percentage of your mortgage costs (ie the interest) will no longer be tax-deductible.
In a nutshell: your mortgage (or any other finance) repayments on residential rentals remains an allowable expense. It's mortgage interest on residential rental property (or any other costs of finance) that won't be.
If you rent commercial property - business as usual.
Hopefully this has answered any questions you may have, but it can be a tough one to wrap your head around.
If you've any questions or want a chat, do please do get in touch with me directly or even drop into the office for a coffee.
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