The mechanism by which landlords receive tax relief for interest and other finance costs is changing from April 2017 … and not for the better. The current rules are more generous than the new rules in that they enable the landlord to receive tax relief at his or her marginal rate of tax. By contrast, the new rules - which are being phased in - will, when fully implemented, provide relief only at the basic rate. Further, relief will be given as an income tax reduction rather than as a deduction from rental income when computing taxable profits.
Under the existing rules, interest and other finance costs, such as fees for arranging a mortgage or loan, are deducted as an expense when working out taxable profits.
John has two properties which he lets out. In 2016/17, he pays mortgage interest of £10,000 on mortgages taken out to buy the properties. He receives rental income of £18,000 in the year and incurs other allowable expenses of £2,000.
The properties are investment properties. John is employed as an IT consultant and in 2016/17 he receives a salary of £70,000. He is a higher rate taxpayer.
For 2016/17 he can deduct the mortgage interest, along with the other expenses, to arrive at a taxable profit of £6,000. Thus, he obtains relief for the mortgage interest at his marginal rate of tax of 40% - thereby reducing his tax bill by £4,000.
Relief for finance costs is to be gradually restricted from 2017/18 onwards, although the restriction only applies in relation to residential properties. It does not affect commercial lets.
The restriction is to be phased in from April 2017 and will be fully in place from the 2020/21 tax year.
In the transitional period, some relief will be given as for the current rules as a deduction in computing profits and relief for the remainder will be given as a basic rate tax deduction.
- For 2017/18, relief for 75% of the allowable interest and other finance costs will be deductible from rental income and relief for the remaining 25% will be given as a basic rate tax deduction.
- For 2018/19, relief for 50% of the allowable interest and other finance costs will be given as a deduction from rental income and the relief for the remaining 50% as a basic rate tax.
- For 2019/20, relief for 25% of the allowable interest and other finance costs will be given as a deduction from rental income and relief for the remaining 25% will be given as a basic rate tax deduction.
- From 2020/21, relief for all allowable interest and finance costs will be given as a basic rate tax reduction.
Based on the facts in the above example, once the restriction is fully implemented, John will receive relief for his mortgage interest costs as a reduction in his tax bill of £2,000 (assuming a basic rate tax of 20%). The change in the rules will ultimately cost him £2,000 a year compared to the current position.
The current rules are more generous than the new rules, and where costs can be brought forward to 2016/17 rather than 2017/18, this can be potentially advantageous to higher and additional rate taxpayers.
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