Private residential landlords. New relief on finance costs rules.

From 6 April 2020, private residential landlords will no longer be able to deduct any of their finance costs from their property income to arrive at their taxable property profits. They will instead receive relief as a basic rate reduction from their income tax liability.

Finance costs include, mortgage interest payments, interest on loans to buy furnishings and also the incidental costs in relation to the administration of finance arrangements, such as fees incurred when taking out or repaying mortgages or loans.

Background

Phasing out of mortgage interest relief via property income deductions began on 6 April 2017.  In the 2017/18 tax year, deductions were restricted by 25% and continued to be restricted by a further 25% each year resulting in a 0% allowable deduction from the 2020/21 tax year.  During the phasing out period, relief was given on the restricted amount as a basic rate reduction from the individual’s income tax liability.  To summarise, since 6 April 2017 landlords received relief as follows: 

Current Position

From 6 April 2020, relief will be given as a basic rate reduction from the income tax liability. The new rules aim of to make the tax system fairer ensuring that landlords with higher incomes no longer receive more tax relief than those on lower incomes. 

To illustrate this in relation to a higher rate taxpayer, the example below provides a before and after case scenario in relation to rental income, assuming a personal allowance of £12,500 and basic rate threshold of £37,500:

Higher rate taxpayer

The following example shows a before and after case scenario in relation to rental income for a basic rate taxpayer, assuming a personal allowance of £12,500 and basic rate threshold of £37,500.  You will note that the new mortgage interest restrictions should not affect the income tax liability for a basic rate taxpayer:

Basic rate taxpayer

However, the mortgage interest restriction may cost basic rate taxpayers in other ways.  Higher rental profits may push basic rate taxpayers who are on the borderline over the threshold into the higher rate tax bracket once finance costs are disallowed in the rental accounts.

The following example shows a before and after case scenario in relation to rental income for an individual who becomes a higher rate taxpayer as a result of the new rules, assuming a personal allowance of £12,500 and basic rate threshold of £37,500:

Basic rate taxpayer becomes a higher rate taxpayer:

In addition, this could lead to an individual being pushed into higher rate tax brackets not only for income tax but for dividend income and capital gains too.  Resulting in a jump in tax from 7.5% to 32.5% for dividends and 18% to 28% for capital gains.

Other knock on effects of breaching the basic rate tax threshold and becoming liable to higher rate tax include:

• Loss of part of the savings allowance, £1,000 is reduced to £500
• Loss of the marriage allowance
• Loss of child benefit, the high-income child benefit charge will apply
• Higher student loan repayments

Summary

In summary, HMRC say 'the measure will impact on those with above average incomes’. However, as we have seen, some people on lower and modest incomes will also be affected. If you think you are likely to be affected by this the way to deal with it is to plan ahead and look at potential ways of reducing taxable income such as increasing pension contributions or considering gift aid.

It is worth noting that the new rules only apply to individuals with residential property businesses.  They do not apply to registered companies, or landlords of furnished holiday lets.

If you would like any further information, please do not hesitate to contact us at DRG Chartered Accountants to talk to our team of tax specialists.

DISCLAIMER: This information is for guidance only, and professional advice should be obtained before acting on any information contained herein. We will not accept any responsibility for loss to any person as a result of action taken or refrained from in consequence of the contents of this publication.