All hopes that the Chancellor would change his mind about the restrictions to income tax relief for landlords of residential properties were dashed in the Autumn Statement when additional charges to Stamp Duty Land Tax on purchases and acceleration of capital gains tax on sale were also announced.
From next April, income tax relief will start to be restricted to the basic rate. This will be phased in over four years to be fully in place by 2020/21. In the first year the restriction will apply to 25% of the interest, 50% the year after and 75% in the third year.
The new rules apply to any interest and finance costs and so would also limit mortgage application fees and interest costs on loans to buy fixtures or furniture. The restrictions do not apply to companies or furnished holiday lettings.
If you are thinking of investing in residential property, careful consideration should be given to the amount of tax relief before taking on a new loan.
How much extra tax will this mean?
The additional tax arising will depend on the marginal rate of tax for the taxpayer. Basic rate taxpayers will not feel the effects of the proposals as much as a higher rate taxpayer who will, in principle, get 20% less relief for finance costs. However, the calculation method may see some taxpayers move into higher rate tax brackets.
Consider the 2020/21 tax year when the transitional period is over. Let’s assume that the personal allowance is £12,000 and the basic rate band is £38,000, and that the higher rate band starts at £50,000. Tony has a salary of £35,000, rental income before interest of £23,000 and mortgage interest of £8,000.
Under current tax rules, taxable rental income is £15,000. He will not pay higher rate tax as his total income is £50,000.
With the new rules, taxable rental income is £23,000. So £8,000 is taxable at 40% = £3,200. Interest relief is given after calculating the tax liability on his income. The relief is £8,000 at 20% = £1,600.
So Tony must pay an additional £1,600 tax.
Can it get worse than this?
Yes it can. Be mindful that:
- The amount of the interest relief is restricted where either the total property income or total taxable income (excluding savings and dividends) of the landlord is lower than the finance costs incurred. For example, if net property income is £4,500 before interest of £6,000, the landlord is making a £1,500 loss but £4,500 is still taxable. Interest relief is also restricted to £4,500 at 20% rather than £6,000 at 20%. Unrelieved interest (£1,500 at 20%) is carried forward and may get tax relief in a later year.
- Child benefit is clawed back if ‘adjusted net income’ of a couple with children is above £50,000. Interest will not be deductible in the calculation of ‘adjusted net income’.
- The personal allowance is reduced if ‘adjusted net income’ is above £100,000.
If you need further information or advice about deduction of interest by residential landlords please speak to your RfM advisor.