From April 2017 changes to tax relief for residential landlords will be introduced. The tax relief that landlords of residential properties can claim for finance costs will be restricted to the basic rate of income tax of 20%. The change will be phased in over 4 years taking full effect by 2020/21.
By 2020/21, finance costs will not be taken into account at all to work out taxable property profits. Instead, once the income tax on property profits and any other income has been assessed, the income tax liability will be reduced by a basic rate ‘tax reduction’. For most landlords, this will be the basic rate value of the finance costs.
The changes to tax relief basically apply where residential property income is subject to income tax and include individuals, partnerships and trusts and estates. The new regime does not apply to companies which are subject to corporation tax. Landlords of furnished holiday lettings are also unaffected by the changes.
The finance costs that will be restricted include interest on mortgages, loans, overdrafts. If you take a loan for both residential and commercial properties, you will need to use a reasonable apportionment of the interest to work out your finance costs for the residential properties. Only the finance costs for the residential property business are restricted. This also applies if your loan was partly for a self-employed trade and partly for residential property.
The new rules will be phased in from April 2017 as follows:
2017/18 – 75% of finance costs allowable, and 25% gets only 20% tax relief
2018/19 – 50% of finance costs allowable, and 50% gets only 20% tax relief
2019/20 – 25% of finance costs allowable, and 75% gets only 20% tax relief
2020/21 – No finance costs allowed against rental profits; 100% gets 20% tax relief.
Example 1
Boris lets out four properties and receives gross rents of £50,000 and pays mortgage interest of £10,000.
| Tax Year | 2016/17 | 2017/18 | 2018/19 | 2019/20 | 2020/21 |
| Rents | £50,000.00 | £50,000.00 | £50,000.00 | £50,000.00 | £50,000.00 |
| Mortgage Interest | -£10,000.00 | -£7,500.00 | -£5,000.00 | -£2,500.00 | £0.00 |
| Total income | £40,000.00 | £42,500.00 | £45,000.00 | £47,500.00 | £50,000.00 |
| Basic rate tax payable at 20% | £5,800.00 | £6,300.00 | £6,400.00 | £6,400.00 | £6,400.00 |
| Higher rate tax payable at 40% | £0.00 | £0.00 | £800.00 | £1,800.00 | £2,800.00 |
| Less 20% tax credit |
£0.00 | -£500.00 | -£1,000.00 | -£1,500.00 | -£2,000.00 |
| Tax payable |
£5,800.00 | £5,800.00 | £6,200.00 | £6,700.00 | £7,200.00 |
| Tax increase on 2016/17 | £0.00 | £0.00 | £400.00 | £900.00 | £1,400.00 |
| % increase on 2016/17 | 0.00% | 0.00% | 6.90% | 15.52% | 24.14% |
The above example shows that in 2017/18 total income increases from £40,000 to £42,500 due to the restriction on mortgage interest. As total income is within the base rate band, there is no additional tax to pay and the tax credit equally offsets the additional tax payable at the basic rate.
However, in years 2018/19 onwards total income falls into the higher rate tax band (over £43,000) and the additional tax payable at 40% is not fully offset by the 20% tax credit leading to an increase in tax payable.
Example 2
David earns £50,000 a year. He also lets out a property for £8,000 a year and pays £3,000 in mortgage interest.
| Tax Year: | 2016/17 | 2017/18 | 2018/19 | 2019/20 | 2020/21 |
| Salary income | £50,000 | £50,000 | £50,000 | £50,000 | £50,000 |
| Rents | £8,000 | £8,000 | £8,000 | £8,000 | £8,000 |
| Mortgage Interest | -£3,000 | -£2,250 | -£1,500 | -£750 | £0 |
| Rental income | £5,000 | £5,750 | £6,500 | £7,250 | £8,000 |
| Total Income | £55,000 | £55,750 | £56,500 | £57,250 | £58,000 |
| Tax | £11,200 | £11,500 | £11,800 | £12,100 | £12,400 |
| Less 20% tax credit | £0 | -£150 | -£300 | -£450 | -£600 |
| Tax payable | £11,200 | £11,350 | £11,500 | £11,650 | £11,800 |
| Tax increase on 2016/17 | £0 | £150 | £300 | £450 | £600 |
The above example shows a loss of higher rate tax relief from 2017/18 onwards. In 2020/21, mortgage interest relief under the old rules would have been £1,200 (£3,000 x 40%). The changes to the tax relief mean that only relief at the basic rate band of 20% is given £600 (£3,000 x 20%). David therefore pays an additional £600 in tax in 2020/21. (Please note, the above examples use the 2016/17 personal allowance and higher rate band threshold for all tax years).
The changes to tax relief for residential landlords mean that the way taxable income is calculated will change and this is likely to have other financial consequences for some taxpayers. For example, taxpayers receiving benefits or paying off student loans where the award is based on the level of taxable income may suffer under the new tax rules.