Before this point, landlords could deduct mortgage interest and other allowable costs from their rental income before calculating their tax.
They could also seek relief in line with their income tax band on these allowable sums.
Under the new regime — which covers landlords letting residential property living in the UK or abroad, those in partnerships, as well as trustees and beneficiaries — once the tax on these profits and any other income has been assessed, the tax payable will be reduced only by the basic rate value of the finance costs, regardless of the landlord’s own tax band.
How is this being phased in?
The percentage of finance costs deductible from rental income is gradually being cut back from 75% in the 2017/18 financial year, to 50% in 2018/19, ultimately to 0% in 2020/21.
The basic rate tax reduction will change from 25% to 100% over the same period.
So let’s look at some examples —
In 2017/18, Sam (a higher rate taxpayer) has £20,000 income from a property with an allowable deduction of £10,000 for mortgage interest
£20,000 (income) minus £7,500 (the mortgage interest minus 75% of allowable deduction) = £12,500
£12,500 is taxable at 40% (his tax rate) = £5,000, minus £500 (£2,500 mortgage interest taxable at 20%)
Total tax due £4,500
But fast forward to 2020/21 and it’s a different picture.
The £20,000 income is now taxable in full at 40% = £8,000
Mortgage relief is restricted to £2,000 (20% of £10,000)
So, the total tax due on the same property is now £6,000
Landlords beware
It’s also worth noting that if you are a basic rate taxpayer, income from property may push you into the higher rate bracket, or it may affect any means tested income.
Plus, if your finance costs (such as mortgage interest) are higher than your rental income, you can only claim basic rate relief on finance costs subject to the amount of rental profit.
Any balance of finance costs can then be carried forward and used to calculate basic rate restriction in future years.
Let’s revisit Sam to illustrate this —
In the year 2020/21, Sam has £10,000 income from property and £20,000 of allowable mortgage interest.
The income is taxed at 40% = £4,000 tax, minus the mortgage interest relief restricted to £2,000 (20% of £10,000)
Total tax due is £2,000, with £10,000 finance costs to be carried forward (£20,000 - £10,000)
In short, chances are as a landlord you’ll pay more tax over the coming years on your rental properties than you have done before, so it’s important so get sound advice on how the changes will affect you and you can make informed choices about your portfolio.
No matter how large or small.
And that’s where our experts can help.
