Since April 2017, restrictions on tax relief for finance costs on buy-to-let residential properties have started to be phased in.
With the first tax returns since this change (i.e. for the 2017/18 tax year) due by January 2019, there could be surprises for some when their tax bill is higher than expected.
The calculations under the new rules are complicated and the methodology could result in more landlords being affected than originally anticipated.
Complex calculations
The restrictions are being phased in over four years with 25% of finance costs being restricted to the basic rate of tax in the 2017/18 tax year, ratcheting up by 25% each tax year following to 100% by April 2020.
Property profits will now need to be calculated gross of the restricted finance costs and taxed at the relevant rates. A tax reducer is then calculated to give relief for the finance costs and is deducted from the tax liability.
The tax reducer is not, however, just calculated at the basic rate (i.e. 20% for 2017/18) of the restricted finance costs. Instead, it is taken as 20% of the lower of:
- Finance costs – costs which have not been deducted from rental income in the tax year i.e. 25% of finance costs for 2017/18 plus any brought forward finance costs (from 2018/19 onwards)
- Property profits – profits of the property business in the tax year (after utilising any brought forward losses)
- Adjusted total income – income (excluding savings and dividend income and after losses and reliefs) in excess of the personal allowance
Watch out for…
The rules and calculation methodology could lead to unexpected results for some landlords, a few examples of such are highlighted below.
Basic rate taxpayers – could be tipped into higher rate tax when gross rental profits before restricted finance costs are taken into account.
Allowances and reliefs - thresholds may be breached to trigger the high income child benefit tax charge or the personal allowance abatement. Eligibility for other tax credits could also be affected.
Individuals with low salary and rental profits – could potentially receive no relief for their finance costs. Where non-savings income (e.g. salary plus rental profits) is below the personal allowance, the tax reducer will be zero (under 3 above) and no relief will be given in the current tax year. This could mean that even basic rate taxpayers may receive nil tax relief for their finance costs. Directors remunerated by way of low salary and high dividends could also be affected.
Losses – landlords could be subject to tax where their property business has made an economic loss. Finance costs will no longer be able to create a rental loss and, instead, any finance costs for which relief is not given in the current tax year will be carried forward for future use.
If you have any questions on how the new rules work, would like to understand the impact it will have on your tax bill and/or what you can do to try and minimise the impact, please do get in touch with Nick Haines or your usual tax contact.