Restricted Interest

From 6 April 2017 changes to the income tax relief on property finance costs mean that interest relief will be restricted for individuals who let residential properties.

Property Finance

The change will be phased in over four years, starting in 2017/18. From 2020/21 individual landlords (not companies) will not be able to deduct any of their finance costs, including mortgage interest, from rental income. In place of a deduction for actual interest paid in the tax year, landlords will receive a 20% tax credit to reduce their tax bill.

Landlords will be taxed on the rents received, less running costs, rather than on the ‘true’ profit/loss made by the lettings business. Landlords who currently make a loss after interest deductions may even end up paying tax on rental income.

Where a landlord’s property business is supported by borrowing, their taxable income will increase such that the marginal tax rate could potentially increase from 20% to 40% or even 45%. When total income crosses the £50,000 or £100,000 thresholds a landlord may also lose some or all of child benefit or personal allowance entitlement.

The following example compares the tax position in 2016/17 (when the landlord receives a deduction for all interest paid) with the position after that deduction is fully removed in 2020/21. The amounts of personal allowance (£12,500) and basic rate band (£37,500) are estimated for the later year:

 

2016/17

2020/21

 

£

£

Salary

35,000

35,000

Rents less running costs

34,000

34,000

Interest deduction

(30,000)

-

Total Net Income

39,000

69,000

Personal Allowance

(11,000)

(12,500)

Taxable Income

28,000

56,500

 

 

 

Tax charged @ 20%

5,600

7,500

Tax charged @ 40%

-

7,600

Tax credit on interest @ 20%

-

(6,000)

Total Tax Payable

5,600

9,100

 

In 2016/17 the landlord is a basic-rate taxpayer and receives child benefit. In 2020/21 the landlord is a higher-rate taxpayer and has lost entitlement to child benefit because total income is over £60,000.

Landlords should review their property financing and consider whether restructuring their lettings business in one or more of these directions is an option:

  • sell residential property and reinvest in commercial buildings
  • let the homes as Furnished Holiday Lettings (which are not affected)
  • transfer the properties into a company

Capital gains tax, stamp duty land tax, the novation of debts and the ability to refinance existing loans will need to be considered, with planning options dependent on the precise facts of each case and the property owner’s future objectives.

For more information on the restriction of interest please contact your local GMcG tax consultant.

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