Major changes to tax relief on finance costs – what are your options?
Property landlords have suffered what has felt like a sustained attack from the Government in recent years. In April 2016, we saw the 3% hike in Stamp Duty Land Tax for the purchase of second homes and the abolition of the 10% Wear & Tear allowance, leaving landlords only able to claim tax relief for the cost of replacing the furniture, furnishings, appliances and kitchenware but not the initial cost.
First announced in the 2015 Summer Budget was perhaps the most controversial change, and one that is expected to have the biggest impact on the buy-to-let market.
The proposal was to restrict tax relief finance costs for residential landlords to the basic rate of income tax. However, the detail behind this headline and the way in which the changes are being introduced needs more explanation.
From April 2017, mortgage interest (and other finance costs) are no longer fully deductible from rental profits for higher rate taxpayers. Instead, landlords receive a basic rate reduction from the income tax liability for their finance costs.
The restriction to tax relief on finance costs is being phased in over a four year period, between April 2017 and April 2020. In the transitional years landlords will be able to claim as follows:
|% of Finance Costs:||2017/18||2018/19||2019/20||2020/21|
|Deductible from rental profits||75%||50%||25%||0%|
|Given as basic rate deduction||25%||50%||75%||100%|
Who do the changes affect?
The changes affect landlords who are higher rate taxpayers, as the tax relief they receive on finance costs will be reduced from 40% to 20%.
But it is important to note that the changes only affect individuals, not companies, so let property held within a company is not affected. Also, they apply to residential property, not to commercial property or Furnished Holiday Lettings.
What other impact can they have?
Due to the way the relief is restricted, the changes will result in the landlord’s taxable income levels increasing, and this can lead to other adverse consequences:
- It could push a basic rate taxpayer into higher rates, which can impact not only rates of Income Tax but also Capital Gains Tax.
- It can affect entitlement to Child Benefit (if total income exceeds £50,000 and triggers the High Income Child Benefit Charge).
- It can restrict or remove entitlement to the Personal Allowance (currently worth £11,500) if total income is pushed above £100,000.
What can I do to mitigate the impact?
Below are some of the main options that landlords should be considering to reduce or avoid the impact of these changes:
- Do nothing and accept the extra tax – but is your business still viable?
- Increase rents to cover the extra tax – but can your tenants bear this?
- Repay your borrowings – it may be possible to use your pension fund
- Transfer property share(s) to lower taxed spouse or family members
- Sell property(ies) – but watch out for Capital Gains Tax
- Transfer existing properties into, or buy future properties via, a limited company
- Switch from shorthold tenancy lettings to qualifying Furnished Holiday Lettings
- Refinance borrowings – if you have a combination of residential and commercial
It is clear that these latest tax changes will have a significant impact on the commercial viability of many property letting businesses, particularly the more highly-geared. Recent press articles have highlighted that the number of available rental properties continues to steadily decline and that, coupled with the potential for many landlords to now raise rents or sell up, will only apply further pressure to the property market.
With interest rates also anticipated to increase over the coming years due to a variety of economic factors, these tax relief restrictions are likely to have an even greater impact as they continue to be phased in. So it is important that landlords are aware of the financial impact of these changes and take advice to consider their options.
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