The Finance Act 2015 introduced
changes to the tax relief available for interest incurred in relation to let
domestic property.
What has changed?
From APRIL 2017 tax relief on interest will be restricted in a
phased pattern so that by 2020 interest will not be deductible when computing
the profits of the business but will instead be allowable as a deduction in
computing the profits at 20%. In other words, relief for interest will be capped
at 20%. This is a move that will affect many including those with single buy to
let properties and those with a larger portfolio. The restriction does not
affect furnished holiday lettings.
What do the changes look like in practice?
The best way to review the
changes is to look at some examples. Obviously, if you are a basic rate
taxpayer, then the change will not affect you – the relief at basic rate is the
same as if you were able to claim the expense as a full deduction from the
profits of the rental property. But people’s income and tax positions are
constantly changing so it is worth reviewing.
The change in relief is being
phased in over a 4 year period as follows:
|
|
% of interest charge allowed as a full
deduction
|
% of interest charge restricted to 20%
relief
|
Effective % Rate of Relief
|
|
2017/18 tax year (commencing 6th April 2017)
|
75
|
25
|
80
|
|
2018/19 tax year (commencing 6th April 2018)
|
50
|
50
|
60
|
|
2019/20 tax year (commencing 6th April 2019)
|
25
|
75
|
40
|
|
2020/21 tax year (commencing 6th April 2020)
|
0
|
100
|
20
|
So for example, should your loan
interest be a straight £2,000 a year, the relief you would be able to claim
would be as follows:
Tax year 2017/18 (ending 5th April 2018) |
Tax year 2018/19 (ending 5th April 2019) |
Tax year 2019/20 (ending 5th April 2020) |
Tax year 2020/21 (ending 5th April 2021) |
|
75% in full: £1,500 in full against profits
|
50% in full: £1,000 in full against profits
|
25% in full: £500 in full against profits
|
0% in full: NIL straight offset against
profits
|
|
25% at 20%: £500 at 20%: £100
|
50% at 20%: £1,000 at 20%: £200
|
75% at 20%: £1,500 at 20%: £300
|
100% at 20%: £2,000 at 20%: £400
|
|
Relief for Higher Rate Tax payers:
|
Relief for Higher Rate Tax payers:
|
Relief for Higher Rate Tax payers:
|
Relief for Higher Rate Tax payers
|
|
£1,500 at 40% = £600
£500 at 20% = £100
Total £700
|
£1,000 at 40% = £400
£1,000 at 20% = £200
Total £600
|
£500 at 40% = £200
£1,500 at 20% = £300
Total £500
|
None in full
£2,000 at 20% = £400
Total £400
|
(Note: For simplicity, assumes 40% higher
rate of tax in all years)
We can also see this in longer
examples:
Investor
with “Small” Rental Property Income
Edwin is a
higher rate taxpayer with two properties bought as investment vehicles. The
change in the rules are as follows:
2015/16 Tax Year: PRE CHANGE
IN RULES
Rental Income (gross) 12,000
Repairs and all other costs 2,000
Mortgage Interest 6,000
Net rental profits £4,000
Tax at 40% £1,600
Compare this
with the situation when the rules have fully changed (please refer to the
tapering of reliefs as on page 1).
2020/21
Tax Year: POST CHANGE IN RULES
Rental Income (gross) 12,000
Repairs and all other costs 2,000
Net rental profits £10,000
Tax at 40% £4,000
Interest Relief at 20%:
Mortgage Interest £6,000 x 20% 1,200
Tax due £2,800
The change is
the £6,000 at 20% = £1,200.
Large Investors
with Substantial Rental Property Income
Using the
example before of Edwin, what if he had established a significant property
portfolio on the basis of considerable borrowing, and was thus a higher rate
taxpayer with multiple properties bought as investment vehicles? For the ease
of the calculation I will assume he has income that uses his basic rate band of
tax. The change in the rules would affect him considerably, as follows:
2015/16 Tax Year: PRE CHANGE
IN RULES
Rental Income (gross) 250,000
Repairs and all other costs 20,000
Mortgage Interest 150,000
Net rental profits £80,000
Tax at 40% £32,000
Again, let us
compare this with the situation when the rules have fully changed (please refer
to the tapering of reliefs as on page 1).
2020/21
Tax Year: POST CHANGE IN RULES
Rental Income (gross) 250,000
Repairs and all other costs 20,000
Net rental profits £230,000
Tax at 40% £92,000
Interest Relief at 20%:
Mortgage Interest £150,000 x 20% 30,000
Tax due £62,000
If you
consider this in cash terms, after paying the mortgage, Edwin would go from
having £80,000 less £32,000 tax due = £48,000 as income, to £18,000 (£80,000
less £62,000 tax in 2020/21). After paying the mortgage, in this example, you
could view the tax liability at 77.5% (£62,000 on £80,000 “profit”).
But consider
again the position if Edwin has even greater borrowings, or the interest rate
increases, and in 2020/21 perhaps the repairs in the property were high. The
situation here could be that the tax due is in excess of the “profits” computed
before the change in the interest relief:
2020/21 Tax Year: POST CHANGE
IN RULES
Rental Income (gross) 300,000
Repairs and all other costs
40,000
Net rental profits £260,000
Tax at 40% £104,000
Interest Relief at 20%:
Mortgage Interest £200,000 x 20% 40,000
Tax due
£64,000
In cash terms,
Edwin has profits of £260,000 less £200,000 mortgage interest, so has £60,000
cash surplus. However, the tax due now is £64,000, so in cash terms, he is
paying out £4,000 for the year from his rental income of £300,000!
Please note
that I have not adjusted the higher rate of tax which will be partly at 45% for
the additional higher rate – potentially making the example even worse.
What Can You Do?
As Chartered Accountants we
are not authorised to give financial advice, but can provide you with
potential solutions to the situation. These would be on a case by case basis
and therefore the following should be seen only as examples. The potential tax
planning might be one of the following:
- Full incorporation – this would involve moving properties and associated loans into a Limited Company. This will involve professional fees for setting the company up and legal fees for transfer of deeds into the Limited company and ongoing, there would be advice required with regards to extracting the profits from the company to the owners/directors. Stamp Duty land tax would ordinarily be available, but relief might be available if the incorporation is of a partnership (i.e. the incorporation is of a partnership not of property owned by individuals). Specialist advice is sought here.
- Pay
down borrowings – this would only be feasible in some circumstances, and
again, would be on a case by case basis.
- Sell
properties – this would remove the issue but might incur capital gains tax
– some of which might be at 28%. Consideration as to the market would be
needed and what to do with the proceeds to replace the potential loss of
income.
- Incur
the extra tax – a simple solution but for many higher rate taxpayers they
might obviously be disappointed to pay the additional tax but may be in a
position where the deemed (potential) increase in the property value and
the lack of desirable alternatives means they will pay the additional tax
incurred by the loss of the interest relief.
- Review
the ownership of the properties – is there a spouse with an unused basic
rate band of income tax who you could transfer the property into joint
names? This has implications outside of potential tax savings of course.
Other Considerations
What will your income position be
like in 2020/21 when the relief is fully implemented at the basic rate only?
Will this affect your decisions now?
Availability of finance – if you
wished to move into a Limited company, is the lending available?
Change in interest rates – if the
tax burden will increase with the current low interest rates, what would your
situation be if the interest rate increased?
How much of your mortgage will be
repaid by 2020/21? Will this affect your tax planning.
We can help
This leaflet should be used as a
general guide and appropriate advice should be sought in all cases when
considering the future of any investments in properties. We offer a free
initial consultation and would be more than happy to meet with you to discuss
matters in general before then giving appropriate advice. To arrange this
please call: 01395 516658 or email advice@easterbrooks.co.uk.
The is a general guide and
Easterbrook Eaton Limited, neither owes nor accepts any duty to any party and
shall not be liable for any loss, damage or expense of whatsoever nature which
is caused by their reliance on the information contained herein.
