Residential Property Letting – Changes announced in Summer Budget 2015 to tax relief on finance costs for buy to let owners
A key change was announced in the recent Budget and this article provides a summary of the change and what action you may want to consider.
Restricting finance costs for landlords
The government will restrict the amount of income tax relief landlords can get on residential property finance costs to the basic rate of income tax. There is, of course, no relief for the capital repayments of a mortgage or loan.
Landlords will no longer be able to deduct all of their finance costs from their property income. They will instead receive a basic rate deduction from their income tax liability for their finance costs. To give landlords time to adjust, the government will introduce this change gradually from April 2017, over a four year period. From 2020/21, all financing costs incurred by a landlord will be given as a basic rate tax reduction.
Please note that the restriction relates to finance costs not just interest – so relief for application fees charged by the lender and financial advisors would also be restricted.
The restriction will not apply to landlords of furnished holiday lettings.
How much extra tax will you have to pay?
This will depend on your marginal rate of tax and the amount of interest expected to be payable. If you are a basic rate taxpayer there will be no substantive changes to your tax bill. A higher rate taxpayer will, in principle, get 20% relief for interest paid rather than 40%. So if interest paid is £10,000 p.a. the extra tax liability will be £2,000 (£10,000 x (40% – 20%)).
The full restriction does not happen until 2020/21. In 2017/18, the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate reduction. So if interest paid is £10,000 p.a. the extra tax liability in 2017/18 will arise on £2,500 of the interest only. This will result in an extra tax liability of £500 (2,500 x (40% – 20%)).
What action can be taken to improve the position?
The restriction in interest relief does not apply to companies. Therefore you may want to consider owning properties through a limited company. However there are a number of issues you will need to think about carefully before you adopt this strategy. In addition the government has announced changes to the taxation of dividends which will impact on the attractions of using a limited company.
If you are thinking about making new investment in residential properties without using a company, you need to factor in the lack of full tax relief in the long term in order to decide the viability of taking on the additional finance.
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