Higher rate tax relief will be restricted for buy-to-let landlords on the costs of finance, including mortgage interest, from 6 April 2017 onwards. The change is being phased in over three years.
All finance costs (not just loan interest) will no longer be an allowable expense when calculating your taxable rental profits. Finance costs include mortgage interest, any payments that are equivalent to interest, and incidental costs of obtaining finance, such as fees and commissions, legal expenses for negotiating drafting loan agreements or valuation fees required to provide security for a loan. Individual landlords are required to make a tax return adjustment so that they only receive a basic rate tax deduction of up to 20% of the finance cost.
Unfortunately, this measure will impact on all taxpayers who incur finance costs who report rental business, under Self Assessment and not just higher rate taxpayers.
Who is affected?
These new rules only apply to individuals with residential property businesses.
They do not apply to companies.
They do not apply to land and property dealing or development businesses, commercial lettings or furnished holiday lets.
Complications for basic rate taxpayers
If you are currently a basic rate taxpayer, you may find that you are suddenly a higher rate taxpayer, once the finance costs have been disallowed in your rental accounts.
You will not know whether the adjustment will take you into higher rate tax without carrying out the computation.
The increase in rental profits will lead to an increase in your total income for tax and this could have knock on effects. One that you may not have considered is the impact for anyone claiming child benefit. If the change increases your income above £50,000, child benefit can be clawed back under the Higher Income Child Benefit Charge (HICBC). You could find that you are paying tax at 40% or higher or that capital gains are taxed at 28% instead of 18%. You may be able to reduce your taxable income with pension contributions or Gift Aid donations.
If you plan ahead we may be able to anticipate whether you are likely to become a higher rate taxpayer as a result of the adjustments.
The change will be introduced gradually from April 2017 as follows:
Year % of costs deducted from profits % of costs available as a basic rate deduction
2017/18 75% 25%
2018/19 50% 50%
2019/20 25% 75%
2020/21 – 100%