Interest relief to be restricted to basic rate
Landlords with large, highly geared portfolios may have to rethink their financing arrangements, or face substantial increases in their tax costs. At present, landlords can deduct relevant finance costs (mainly mortgage interest) as an expense of their property business. This relief is effectively given at the taxpayer’s highest rate of tax.
For example. Jim has non-property income of, say £50,000 which fully uses his personal allowances and basic rate band. Jim also lets several properties on high LTV mortgages. His gross property income is £30,000 out of which he pays mortgage interest of £20,000. His net property income is therefore £10,000. Jim will pay £4,000 tax on this net property income, being 40% of £10,000.
In future, interest relief will be given as a tax deduction from total income, but restricted to basic rate (currently 20%).
In Jim’s example, the gross property income of £30,000 will suffer £12,000 tax at 40%, from which Jim will be able to deduct interest relief of £4,000 (20% of £20,000), giving a tax cost of his property income of £8,000 (£12,000 minus £4,000). Put another way, his net property income of £10,000 will suffer tax at 80%! It is not hard to construct examples where the tax cost is even greater than the net property income.
To allow time for planning, these changes are being phased in, starting in 2017/18 and will be fully effective in 2020/21.
Landlords affected by these changes might consider:
- Selling part of the portfolio to repay loans
- Reducing gearing by other means
- Transferring the properties to a company (companies are not affected by this change)
Each of these options has other significant tax implications that need to be weighed up.
This is a brief introduction to a complex issue. You should take professional advice, tailored to your personal situation, before taking any action on the matters discussed here.
We are (once again) grateful to accountant Tony Tesciuba, of Tesciuba Limited, for providing this guidance.