What the new interest relief restrictions mean for you

What the new interest relief restrictions mean for you

The tax and interest treatment for property owners has long been an ever-changing subject, especially in the recent Budget and Statement announcements. With legislation being announced, dropped, changed and muddled, it’s any wonder property landlords are wondering what is the best move for them.

We’ve already covered why incorporating your buy-to-let business might not be the successful venture you’ve been promised, but now it’s time to dive in deeper.

A lot of property businesses come to us with so many misconceptions around interest relief, so we wanted to set the record straight and address what the new restrictions are and how it could impact you:

What are the restrictions?

The tax relief restrictions on interest and finance costs relating to residential property lettings will be phased in over the next four years. At the same time, higher rate tax relief for interest and finance costs will be phased out. By 2020/21, these costs will no longer be an allowable expense against rental income.

The restrictions will look like this:

  • 2017/18– 75% deducted as normal, 25% relieved at basic rate
  • 2018/19– 50% deducted as normal, 50% relieved at basic rate
  • 2019/20– 25% deducted as normal, 75% relieved at basic rate
  • 2020/21– All relieved at basic rate

As it stands, these restrictions will only apply to individual landlords who own residential property, and not to companies, commercial properties, or furnished holiday lets.

How is the tax reduction calculated?

This is where things can get a little tricky. According to HMRC, the reduction is the basic rate value (which is currently 20%) of the lower of:

  • Finance Costs– “costs not deducted from rental income in the tax year (this will be a proportion of finance costs for the transitional years) plus any finance costs brought forward”
  • Property Business Profits– “the profits of the property business in the tax year (after using any brought forward losses)”
  • Adjusted Total Income– “the income (after losses and reliefs, and excluding savings and dividends income) that exceeds your personal allowance”

Note:This tax reduction can’t be used to create a tax refund.

What does it look like in action?

The GOV.UK website has a number of different examples of the restrictions in action, covering a few scenarios, the most interesting of which shows no increase in tax. 

According to HMRC, an estimated 82% of landlordswon’t have any additional tax to pay, because their total income, without a deduction for finance costs, won’t exceed the higher rate threshold.

Here’s what that will look like before and after the full restriction is in place from 2020/21:

Let’s imagine you have rental income of £40,000, finance costs of £15,000, and other allowable expenses amounting to £7,000.

Before the restriction (2016/17)

After the restriction (2020/21)

Rental Income =                     £40,000

Finance costs =                      £15,000

Other allowable expenses =   £7,000

 

Profits =                                  £18,000

Total income =                                    £18,000          

Rental Income =                     £40,000

Finance costs (£15,000) =      No deduction

Other allowable expenses =   £7,000

 

Profits =                                  £33,000

Total income =                                    £33,000          

Now for the calculation (HMRC has used the 2016/17 Personal Allowance throughout its examples to keep things simple – I’ll do the same here).

Income Tax (2016/17)

Income Tax (2020/21)

£11,000 x 0%     =  £0

£11,000 x 0%     = £0

£7,000 x 20%     = £1,400

£22,000 x 20%   = £4,400

£0 x 40%           = £0

£0 x 40%           = £0

Final Income Tax: £1,400

Here we take away the 20% tax reduction for finance costs:

 

£15,000 x 20% = -£3,000

 

Final Income Tax: £1,400

As mentioned previously, the tax reduction is calculated as 20% of the lower of:

  • Finance Costs – £15,000
  • Property profits – £40,000
  • Adjusted total income (exceeding Personal Allowance) = £22,000

Where’s the confusion?

Many buy-to-let property owners have been left scratching their heads over this change. With interest and finance costs being phased out as allowable deductions, it will increase their overall taxable income. And this could have some far-reaching effects on other parts of their lives.

For instance, it could push them into a higher rate of income tax, reduce their personal allowance (if their income exceeds £100,000), restrict the amount on which they can claim tax relief for pensions, and even affect child benefit entitlement.

In summary

There’s no doubt that the new restrictions with interest rates are leaving property owners doubting their financial position.

If that’s you, then we’re here to help set the record straight and provide the support that you’ll need to keep things clear. Get in touch today to find out more.