Interest relief for residential buy-to-let properties

Historically, full tax relief has been available for loan interest payments made by a rental business, but changes to interest relief were introduced in April 2017 and are being phased in over a four year period, so the full effect will be felt from April 2020.

Interest relief for residential buy-to-let properties

A rental business will no longer receive a deduction for the interest payments in their accounts. Instead you will claim relief at 20% as a ‘tax credit’ against your final liability. The restriction introduced applies to individuals, partnerships and trustees carrying on a rental activity, with the only exception being property used as furnished holiday lettings.

The changes will gradually reduce the deduction available in the accounts each year by 25% as follows:

Restrictions

The restriction will also apply for any costs the business incurs for arranging future loans or mortgages. Tax relief will be given as a tax credit, so consequently the legislation includes restrictions to ensure the credit does not create a tax repayment. These restrictions also ensure that property businesses do not lose potential tax relief as unused relief can be carried forward.

If the interest paid during a tax year is greater than the business’ gross rents or taxable profit, then interest relief available in the year is reduced to 20% of the lower of the gross rents or profits. Any interest unrelieved in any tax year is be carried forward and treated as interest paid in the following year. Any interest carried forward in any of the transitional years, will be subject to the same allocation as detailed above.

There is also a restriction to limit the relief if an individual’s adjusted total income is less than the total interest available for relief under the new tax credit system. The adjusted total income for this purpose is the total income (ignoring other savings and dividend income) less any personal allowances available to the taxpayer.

Profitability of rental businesses will largely depend on the level of funding currently in the business and future funding requirements to grow the business. A business with low level borrowings will not be affected as badly as those using debt to expand their portfolio.

Summary

The impact is clearly dependent upon the size of the property business and the level of funding within it.

Smaller businesses

For smaller businesses there is a tax increase. However the level of funding will determine whether retaining the property in the current format is appropriate. You may wish to take advice to understand your net position and whether you need to consider the funding profile of your existing business.

Larger and growing businesses

You should also consider their current structure and how this may be affected. There is the possibility of incorporating the property business. In some circumstances a business may attract incorporation relief under section 162 of the Taxation of Chargeable Gains Act (TCGA). Under section 162, you can exchange properties (at market value) for shares in the company. Relief may also be available from Stamp Duty Land Tax, if the existing business currently operates as a partnership.

Limited companies

There is also the difficulty of persuading lenders to change the basis of lending to a limited company. These changes will effect both an existing property business and new investors alike. There is still a significant amount of time before they take full effect. As a result, we recommend all property investors consider how the proposals will affect them.

Effective tax planning

Above all, make sure you take advantage of any opportunities that are available prior to April 2020.

This example demonstrates how both the tax payable and profitability figures for a large property business will be affected when the changes take full effect in April 2020:

Example

Sally and Ian are married and have built up and manage a substantial property portfolio between them.The income generated is their major source of income, but they have borrowed significantly to build their portfolio to its current size.

Sally and Ian’s joint tax position for 2016/17 was:

Sally and Ian’s joint position in 2020/21 paints a much bleaker picture following the changes, assuming the other factors remain consistent:

Both Sally and Ian now have taxable income of £175,000, so lose their personal allowance as it is in excess of £100,000. Their joint tax position is now:

*Using 2018/19 allowance and rate bands

Please note that this Tax facts page is for general information purposes only. You should seek professional advice before you take any action, or refrain from as a result of information contained herein. Content last updated: 29/6/18.

For more information

Please call our Tax advisory team on:

01483 416232