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Tax Relief Restrictions and Incorporation for Landlords

 

From 6 April 2017, landlords are no longer be able to deduct all of their finance costs from their property income. As an alternative, they will receive a basic rate reduction from their income tax liability for their finance costs.

Finance costs include:

  • Interest and other finance costs on loans taken for a property business which involves the letting of residential properties.
    • Loans that are taken wholly for commercial properties and furnished holiday letting business are not affected.
  • Any payments that are equivalent to interest related to loan
  • Any incidental costs incurred when obtaining a loan such as fees or commission payments. This also includes legal expenses and valuation fees.

The restriction will apply as follows:

Year Deductible Reducer
2017/18 75% 25%
2018/19 50% 50%
2019/20 25% 75%
2020/21 0% 100%

 

The changes only apply to individuals, joint owners and partners. It does not apply to limited companies but applies to individuals with high gearing.

Examples:

Linda has employment income of £50,000 in 2017/18. The property income before interest is £12,000 and mortgage interest is £3,000. The non-deductible interest is 25% of £3,000 which is £750.

 

  £
Employment Income 50,000
Rental Income (12,000 – 2,250) 9,750
  59,750
Personal Allowances (11,500)
Taxable Income 48,250
   
Basic rate at 20% 6,700
Higher rate at 40% 5,900
  12,600
   
Less interest relief at 20% on £750* (150)
Net Tax Liability 12,450

 

*Lower of rental income (£9,750), adjusted total income (£48,250) and disallowed property finance cost (£750)

 

Jorge has employment income of £20,000 in 2017/18. His property income before interest is £2,800 and mortgage interest is £3,500. He has property losses brought forward of £3,000.

 

The non-deductible interest is 25% of £3,500 which is £875.

 

  £
Employment Income 20,000
Rental Income (2,800-2,625-175 (loss relief)) 0
  59,750
Personal Allowances (11,500)
Taxable Income 8,500
   
Basic rate at 20% 1,700
  6,800
   
Less interest relief at 20% on £0* (0)
Net Tax Liability 1,700

 

*Lower of rental income (£0), adjusted total income (£8,500) and disallowed property finance cost (875)

 

  • Interest carried forward to 2018/19 (£875-0)
  • Property losses carried forward to 2018/19 (£3,000-£175)

 

Individuals with high gearing should consider to incorporate in order to minimise the impact of the new property legislation.

 

 

Tax implications for clients who rely on rental surplus for income

 

Paula who is a higher rate taxpayer has a property portfolio with a market value of £900,000 and borrowings of £675,000 at 2%. Her net rental yield is 4% and he relies on the rental surplus for income.

 

Individual

  2017/18 2018/19 2019/20 2020/21
Net rental income (4%) 36,000 36,000 36,000 36,000
Finance costs allowed  (10,125)  (6,750) (3,375) Nil
Rental Profit 25,875 29,250 32,625 36,000
Tax at 40% (10,350) (11,700) (13,050) (14,400)
Tax reducer 675 1,350 2,025 2,700
Post tax income 12,825 12,150 11,475 10,800

 

 

 

Corporate

  2017/18 2018/19 2019/20 2020/21
Net rental income (4%) 36,000 36,000 36,000 36,000
Finance costs allowed  (13,500) (13,500) (13,500) (13,500)
Rental Profit 22,500 22,500 22,500 22,500
Corporation Tax (4,275) (4,275) (4,275) (3,825)
Dividend 18,225 18,225 18,225 18,675
Post tax dividend 12,302 12,302 12,302 12,605
Corporate saving (523) 152 827 1,806

 

 

Tax implication for clients that invest for capital growth reasons

 

Harvey and Donna are married. They both run a substantial rental property business. They each spend 35 hours a week managing the business.

 

  2016/17 2020/21
Gross rents 500,000 500,000
Repairs and other tax-deductible costs 150,000 150,000
Interest on mortgage 300,000 0
Net rental profit 50,000 350,000
Personal allowances for both of them 22,000 0
Taxable income 28,000 350,000
     
Basic rate tax for both of them 5,600 15,000
Tax at 40% 0 90,000
Tax at 45% 0 22,500
    127,500
Less interest relief at 20% on £300,000 0 (60,000)
Net tax liability on rental income 5,600 67,500
     
Tax increase   61,900
Effective rate on ‘real’ rental profit 11.2% 135%

 

In conclusion, transferring an existing rental business to a limited company might not be the best option for Paula. However, it might be best for Harvey and Donna to consider incorporating.

If you have the same circumstances as the above, please don’t hesitate to contact us on 01772 788200 or email info@taxexpert.co.uk for professional advice.