menu
Springfords LLP News

To receive our quarterly e-newsletter filled with the kind of news you can use, register here.

Let Residential Property Tax Update

21 April 2017

There have been many changes to the taxation of property in recent years.

One of the more significant, whose impact will increasingly bite in years to come, is the restriction to tax relief available to individuals (including both UK and non-UK resident individuals and individuals in partnership) on interest and related finance costs incurred in connection with let residential properties.

The new rules do not apply to companies (whether UK resident or not), furnished holiday lets or commercial properties.

A summary of the changes, and potential steps which could be undertaken to mitigate their impact, is noted below.

Restriction of tax relief on interest

Up until 6 April 2017, all interest paid by individuals in connection with residential buy-to-lets (whether in the UK or overseas) qualified for tax relief by way of a deduction from rental surpluses, so qualified for tax relief at the landlord’s marginal rate of income tax.

From 6 April 2017, the deduction is gradually phased out (see table below)

 

  2017/18

  2018/19

  2019/20

  2020/21

% of interest allowed as a deduction from rental surpluses

       75

       50

       25

       0

% of interest given at basic rate (currently 20%) as a credit

       25

       50

       75

      100

and fully replaced, by 6 April 2020, with a basic rate (currently 20%) deduction which, crucially, is not deducted from rental surpluses but is instead given as a credit against the individual’s tax liability.

These changes will therefore not only restrict tax relief on interest but will also increase the landlord’s total taxable income. This could result in individuals moving from basic rate to higher rate status without any actual increase to their income - as illustrated in the example below.

Example

Joe has three let properties and is currently a basic rate taxpayer.   

 

 

2016/17

2020/21

   £  £
Rent 25,000 25,000
Interest (10,000) -
Other expenses     (5,000)    (5,000)
Taxable profit on property  10,000 20,000
Other taxable income   33,000   33,000
Total taxable income     43,000    53,000
Less:Personal allowance    (11,000)   (11,000)
Chargeable 32,000 42,000

Tax due (using 2016/17 rates) £32k at 20%

6,400 6,400
Balance at 40%                  -   4,000
  6,400 10,400

Loan interest BR deduction (0/£10,000 at 20%)

      N/A    (2,000)
Total tax due 6,400 8,400

 

The above example assumes that the personal allowance and basic rate band for 2020/21 remain at their 2016/17 levels of £11,000 and £32,000 respectively. Joe’s actual total income net of interest paid for both years also remains at £43,000, so Joe may be surprised to find that the effect of the new rules is that he ends up with £10,000 of income subject to tax at the higher rate of 40%, which, after taking account of the 20% tax credit, results in him having to pay £2,000 more tax on the same level of income.

As the new legislation requires interest on let residential properties to be added back when calculating taxable income, it could also result in additional tax being payable if:

  • an individual or their spouse receive child benefit and the above changes result in that individual's total taxable income exceeding £50,000; or
  • the new rules result in that individual's total taxable income exceeding £100,000 and thus restrict their personal allowances.

It is even possible that an individual could end up being taxed on rental losses!

For example, if a higher rate individual received rental income in 2020/21 (once the new rules are fully operational) of £10,000, had rental expenses of £4,000 and paid interest of £7,000, they would have realised an actual commercial rental loss of £1,000 but would have taxable rental income (once the interest is added back) of £6,000 with tax payable thereon at 40% of (£2,400). Because further restrictions ensure that gross interest costs given by way of credit cannot exceed net property income, the tax credit for interest paid would be limited to £1,200 (being £6,000 at 20%) so, in this example, net tax of £1,200 would be payable on a rental loss of £1,000.

So, what can be done to limit the impact of these new rules?

For larger property portfolios (particularly those with significant gearing held within partnerships) it may be worthwhile incorporating the property business.

Borrowing could also be refinanced to ensure that interest is only paid on loans qualifying for full tax relief.

For those whose spouses pay tax at a lower rate, properties (or a part interest in them) could be transferred inter-spouse to:

  • better use the transferee’s personal allowance and lower rate bands
  • access more than one capital gains tax exemption; and
  • avoid additional tax potentially being payable by those who have received child benefit or a restriction to personal allowances of the transferor spouse.

Finally, if acquiring let residential properties, consideration should be given to whether or not it would be more tax efficient to acquire them through a company.

Please keep an eye on our website for further updates but if, in the meantime, you need any further information on the above please contact Jimmy Hair at jhair@springfords.com.

Contact Us
  terms & privacy
Part of Baldwins