Important reminder: landlords’ tax bills to rise again

With the EU referendum and the uncertainty created following a Brexit vote, it is easy to forget the upcoming changes to the buy-to-let sector that could significantly reduce landlords’ profits.

The government has issued guidance and examples on the restriction of income tax relief for interest costs incurred by landlords of residential properties. The new rules, which are phased in from April 2017, follow on from the introduction of the Stamp Duty levy earlier this year and the amendments to the wear and tear allowance.

The changes

From April 2017 income tax relief will start to be restricted to the basic rate of tax. The restriction will be phased in gradually over four years and be fully in place by 2020/21. In the first year the restriction will apply to 25% of the interest, then 50% the year after and 75% in the third, before all financing costs incurred are given as a basic rate reduction from 2020/21.

Who’s affected?

The changes only apply to residential properties and do not apply to companies or furnished holiday lettings.

The changes will affect UK resident individuals that let residential properties in the UK or overseas, non-UK resident individuals that let residential properties in the UK, individuals who let residential properties in partnership, and trustees or beneficiaries of trusts liable for income tax on property profits.

The impact

The restriction may result in additional amounts of tax being due but will depend on the marginal rate of tax for the taxpayer. Basic rate taxpayers should not be substantively affected by these rules. A higher rate taxpayer will, in principle, get 20% less relief for finance costs – which could lead to a significant increase in tax bills.

However, the calculation method may mean that some taxpayers move into the higher rate tax brackets.

The following example illustrates this:

Consider the 2020/21 tax year when the transitional period is over. Assume that the personal allowance is £11,000, the basic rate band £32,000 and the higher rate band starts at £43,000.

Assume Ellisha has a salary of £28,000, rental income before interest of £23,000 and interest on the property mortgage of £8,000. Under the current tax rules, taxable rental income is £15,000. She will not pay higher rate tax as her total income is £43,000 – the point from which higher rate tax is payable.

With the new rules, taxable rental income is £23,000. So £8,000 is taxable at 40% – £3,200. Interest relief is given after having computed the tax liability on her income. The relief is £8,000 at 20% – £1,600. So an extra £1,600 tax is payable.

Other complications

It should be noted that the tax reduction cannot be used to create a tax refund. So the amount of interest relief is restricted where either total property income or total taxable income (excluding savings and dividend income) of the landlord is lower than the finance costs incurred. The unrelieved interest is carried forward and may get tax relief in a later year.

Child benefit is clawed back if ‘adjusted net income’ 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.

In summary

There are many complications to consider in this increasingly complex are of tax.

, and the need to take advice – e.g. complications if relief cannot be used in the relevant year, the complexity of the computations  etc.

Please contact us if you would like advice on how these rules will affect you.

More from our tax experts

You can find all of our latest tax articles and tax resources here.

If you are looking for advice in a particular area, please get in touch with your usual Hawsons contact.

Alternatively, we offer all new clients a free initial meeting to have a discussion about their own personal circumstances – find out more or book your free initial meeting here. We have offices in Sheffield, Doncaster and Northampton.

Craig Walker is a senior tax manager at the firm. He advises on all matters tax related, both corporate and personal, including income, capital gains and inheritance. For more details and advice, please contact Craig on [email protected] or 0114 266 7141.

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