Higher rate tax relief is restricted for buy-to-let landlords on the costs of finance, such as mortgage interest, from 6 April 2017 onwards.

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  • The change is being phased in over three years.
  • It means that all finance costs (not just loan interest) will no longer be an allowable expense when calculating your taxable rental profits.
  • individual landlords are required to make a tax return adjustment.
  • The adjustment will give you a basic rate tax deduction after the rental profits have been taxed. This deduction will be up to 20% of the finance cost.
  • Unfortunately, this measure will impact on all taxpayers who incur finance costs who report rental business, under Self Assessment and not just higher rate taxpayers.
  • Finance costs include mortgage interest, any payments that are equivalent to interest, and incidental costs of obtaining finance, such as fees and commissions, legal expenses for negotiating drafting loan agreements or valuation fees required to provide security for a loan.

Who is affected?

  • These new rules only apply to individuals with residential property businesses.
  • They do not apply to companies.
  • They do not apply to land and property dealing or development businesses, commercial lettings or furnished holiday lets. 

Complications for basic rate taxpayers

  • If you are currently a basic rate taxpayer, you may find that you are a higher rate taxpayer, once the finance costs are disallowed in your rental accounts.
  • Your tax liability depends on your other income and the amount of finance costs that are added back.
  • You will not know whether the adjustment will take you into higher rate tax without going over a series of steps in order to work out the effect of the change. 
  • If you do become a higher rate taxpayer after arriving at your rental profits, you will lose higher rate tax relief on your finance costs.
  • You continue to receive basic rate tax relief on your other costs.

Practical considerations:

  • The increase in rental profits will lead to an increase in your total income for tax.
  • The knock on effects depend on your personal circumstances, other income, capital gains and other reliefs.
    • For example, there is an impact for anyone claiming tax credits or if you or your partner claim child benefit and the change increases your income above £50,000, child benefit can be clawed back under the Higher Income Child Benefit Charge (HICBC).
  • You could find that you are paying tax at 40% or higher or that capital gains are taxed at 28% instead of 18%.
  • You may be able to reduce your taxable income if you carry back pension contributions or Gift Aid donations from the next year.
  • If you plan ahead we may be able to anticipate whether you are likely to become a higher rate taxpayer as a result of the adjustments.

Phased introduction:

The change will be introduced gradually from April 2017 as follows:

Year % of costs deducted from profits % of costs available as a basic rate deduction
2017/18 75% 25%
2018/19 50% 50%
2019/20 25% 75%
2020/21 - 100%

 

Further restrictions

The basic rate deduction is up to 20% of the disallowed finance costs.  The deduction is restricted in some circumstances, such as the following:

  • When property profits are less than finance costs, the deduction is limited to 20% of the property profits.  The reduction does not reduce tax payable on other sources of income.
  • When there are property losses brought forward these must be set against property profits and could reduce the taxable profit to less than the finance costs.  Here the deduction is limited to 20% of the taxable profits.
  • When total income (excluding any savings or dividend income which are taxed as top-slices) is low, so that some or all of the rental profits fall within the personal allowance, the deduction is restricted to 20% of the profits that are actually taxed.

When there is a restriction, any finance costs which have not been used to calculate the basic rate deduction in one year can be carried forward and added to the finance costs of the following year.

For worked examples see:

Restricting mortgage interest relief (subscriber guide)
This practical guide explains the detail behind the restriction on interest relief, it comes with examples to assist landlords in making the right choices in restructuring their property businesses.

Incorporating a buy to let business
This guide illustrates some of the tax savings that may be achieved by running the business via a company.

Our Land & Property section
This contains our guides on this topic.