Government publishes guidance on changes to tax relief for residential landlords

28 July 2016

In Budget 2016 the Government announced that from April 2017 the tax relief that landlords of residential properties get for finance costs will be restricted to the basic rate of income tax. These changes follow others previously discussed here. On 20 July 2016, the new guidance was published and is summarised below.

The current rules permit residential landlords to deduct ‘allowable expenses’ from any gross rental income in order to arrive at the taxable profits of the business. Allowable expenses are certain items that landlords need to spend money on wholly and exclusively for the purposes of renting out the property, such as letting agent fees and utility bills. However, allowable expenses don’t include ‘capital expenditure’ - like mortgage capital repayments or renovating or improving a property beyond repairs for wear and tear.

Under the new changes, finance costs won’t be taken into account to work out the gross rental income that is taxable. Instead, once the income tax on rental profits and any other income sources has been assessed, the landlord’s income tax liability will be reduced by a basic rate ‘tax deduction’. For most landlords, this will be the basic rate value of the finance costs.

Who will be affected?

You may be affected if you are:

  • A UK resident individual that lets residential properties in the UK or overseas
  • A non-UK resident individual that lets residential properties in the UK
  • An individual who lets such properties in partnership
  • A trustee or beneficiary of trusts liable for Income Tax on the property profits

All residential landlords with finance costs will be affected, but only some will pay more tax.

You won’t be affected by the introduction of the finance cost restriction if you are:

  • A landlord of commercial rather than residential property
  • A UK resident company
  • A non-UK resident company
  • A landlord of Furnished Holiday Lettings

What’s included under the finance cost restriction?

The finance costs that will be restricted include interest on mortgages, loan (including loans to buy furnishings) and overdrafts.

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

Landlords who take a loan for both residential and commercial properties need to use a reasonable apportionment of the interest to work out their finance costs for the residential properties. Only the finance costs for the residential property business are restricted. This also applies if the loan was partly for a self-employed trade and partly for residential property.

When will the changes happen?

The restriction will be phased in gradually from 6 April 2017 and will be fully in place from 6 April 2020. During the transitional period, landlords will still be able to deduct some finance costs when working out taxable property profits.
According to a table supplied by HMRC, landlords will be able to deduct 75% of finance costs from rental income in 2017/18 and use a 25% basic rate tax reduction. This becomes 50% finance costs deduction and 50% of basic rate tax reduction in 2018/19, then 25%/75% before reaching 0% deduction of finance costs and 100% basic rate tax reduction in 2020/21.

Other implications of the restriction

These changes may have other implications for some landlords, for example as the new rules will increase a landlord’s “gross income” this could affect their or their partner’s ability to claim child benefit if it pushes their gross income over £50,000.

Whilst some landlords may consider increasing the amount of rental income so as to pass the additional costs on to their tenant, this may not only be difficult (particularly if they have already tried to pass on the cost of the recent SDLT changes and/or changes to the wear and tear allowance, or otherwise restricted by their lease by increasing rent in this manner) but could also mean that the landlord’s liability for rental income would increase. 

Further information

To work out the tax relief for individual landlords and assess the impact of the finance cost restriction, follow this link to the website or contact us a member of our private client team for advice. 

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