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Residential property lettings – update on recent income tax changes


1. Residential landlords – restriction of tax deductions for loan interest

Currently, interest (and other finance costs) are a deductible expense for any property business. However, from April 2017 this will be restricted for individuals and trusts residential property lettings. This restriction will be phased-in so that by April 2020 there will be no deduction allowed for the interest costs of a property business. Instead, there will be a “tax reducer” which will give a basic rate tax deduction (20%) of the finance costs from the tax bill.

As currently drafted, the interest costs are to be restricted for every residential property lettings business excluding corporates and furnished holiday lettings, with the tax reducer being available to individuals, personal representatives and trustees. The tax relief restriction will be phased-in as follows:

Example

Take a highly geared residential portfolio landlord with gross rents of £100,000, expenses other than interest £30,000, interest expense £50,000, other income of £11,000. The increase in tax payable for tax years 2016/17 to 2020/21 will be calculated as follows:

In this example

• Landlord has gone from being a basic rate (20%) taxpayer to being a higher rate (40%) taxpayer.
• A High Income Child Benefit Charge (HICBC) may be due, depending on the other circumstances (such as being in receipt of child benefit!)

Depending on the numbers, the rule changes could mean that

• A taxpayer who wasn’t previously affected is pushed into the band above £100,000 where the Personal Allowance is abated (at an effective 60% tax rate) or
• He/she becomes an additional rate taxpayer where they were not previously.
The legislation is included in the 2016 Finance Act, recently passed into law.

The result is that we now have a complete minefield of tax rules relating to residential property and different rules apply whether the property is owned by a company, individually or in trust.

The above loan interest restriction is a significant change and the phase-in will allow landlords to consider their positions going forwards.

This restriction does not apply to commercial properties, and the commercial letting of furnished holiday lettings is specifically excluded.

2. Other tax changes

There are two other changes to note on property income. From April 2016 the “Wear and Tear Allowance”, which allows a deduction from net rents to cover the cost of replacing items in a fully-furnished property, will be replaced with a new relief that allows all residential landlords to deduct the actual costs of replacing furnishings. This change does also apply to companies.

For landlords letting out rooms in their own homes, there is a welcome increase in the level of Rent-a-Room relief from £4,250 to £7,500 per annum effective from 6 April 2016.

Conclusion

Clearly these changes will affect many residential landlords, in particular those with high levels of gearing or with mortgages at high interest rates. Landlords should now be calculating the projected effect of the above changes on their future tax position in terms of net yield and ongoing financial viability. Anyone who is concerned as to how these changes may affect their financial position should take early tax advice as to their options to potentially mitigate the anticipated increases in tax bills, e.g. incorporation.

Ian Pring, Tax Consultant at PKF Francis Clark LLP who specialises in property taxation (including SDLT and Capital Allowance.