Restriction on tax relief for residential property finance costs

3 Aug 2019

Residential property

The law has been changed from 6 April 2017, in order to restrict the finance costs which can be deducted from rental income during a tax year. The restriction will apply to mortgage interest, interest on loans to buy furnishings, and fees incurred when taking on and repaying mortgages or property loans.

The new rules apply to:

  • UK resident individuals who let residential properties in the UK or overseas;
  • Non-UK resident individuals who let residential properties in the UK;
  • Individuals who let residential properties in partnership; and
  • Trustees or beneficiaries of trusts liable for income tax on the property income profits.

The new rules do not apply to:

  • UK and non-UK resident companies; and
  • Furnished holiday lettings and commercial lettings.
  • The change is due to be phased in over three years from 6 April 2017.

The restrictions

The restrictions mean that tax relief at the marginal rate of tax (depending on the overall level of income) will no longer be available in full from 6 April 2017 and will not be available at all from 6 April 2020.

From 2017-18 a proportion of the finance costs associated with rental property will be restricted to tax relief at the basic rate of tax only. This will be achieved by giving a
reduction in the tax liability equivalent to a basic rate tax credit.

For each tax year, the income tax deduction will be calculated as 20% of the lower of:

  • Finance costs – costs not deducted from the rental income in the tax year.
  • Property profits – the profits of the property business in the tax year (after using any brought forward losses).
  • Adjusted total income – the income (after losses and reliefs, and excluding savings and dividend income) that exceeds the personal allowance.

The tax reduction cannot be used to create a tax refund, but basic rate relief will not be lost as it may be carried forward to the following years. Similarly, if finance costs remain unrelieved because they have been restricted, they may be carried forward.

The ability to carry amounts forward will be beneficial to those with a temporary reduction in property income – perhaps because a property is vacant for a period – or a short-term increase in costs (for example because of a refurbishment).

Impact of the restrictions

The new rules may have an impact on other aspects of a taxpayer’s overall tax position. Here are some examples of where this could occur:

  • Basic rate taxpayers may be pushed into the 40% tax band.
  • Those currently in receipt of income below the threshold for the high income child benefit tax charge may become liable to the charge.
  • The taxable income of some individuals may breach the threshold for abatement of the personal allowance, which could mean they need to pay a marginal tax rate of 60% (which applies to incomes between £100,000 and £123,000 in 2017-18).
  • The higher income levels may affect eligibility for and levels of tax credits.
  • Landlords may have a taxable profit in relation to their rental business for periods in which they realise an economic loss.

The position for trusts

The manner in which the restriction will operate for trusts is complex. The trustees of discretionary trusts will be able to apply the basic rate tax reduction, but trustees of life interest trusts will not. In the latter case, life tenants will need to claim the basic rate tax reduction in their personal tax returns. We recommend that you contact a trust tax specialist to discuss in more detail how relief for finance costs will operate in relation to specific trusts.

Summary

These changes represent a challenge to residential property landlords, particularly those who have borrowed heavily to finance their property acquisitions. In some cases there may be a need to rationalise property holdings in order to mitigate the effects of the finance costs restriction.

This factsheet is based on law and HMRC practice at 1 August 2019.

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