Landlords – restriction to relief on finance costs/withdrawal of Wear & Tear Allowance
Who this affects:
>Landlords paying the higher rate of tax who claim interest on a mortgage or loan as an expense against their rental income.
>Landlords with furnished lets claiming the Wear & Tear Allowance.
>Increased tax liability/restriction on property losses
>Increased tax liability/increased record keeping requirements
Restriction to relief on finance costs
As part of the Chancellor’s summer 2015 budget, he has imposed a restriction on the tax relief available on landlord’s finance costs. Broadly, this means that the amount of tax relief a landlord can have on mortgage or loan interest will be restricted to 20% (the basic rate of tax).
The change will be introduced gradually from April 2017 before reaching full implementation in 2020-21.
Landlords will no longer be able to deduct loan interest from their rental profits, instead they will receive a basic rate tax reduction from their income tax liability. This is an important distinction as not only is the relief being restricted but loan interest will no longer be able to generate or increase a rental loss.
Relief will be available as follows:
>in 2017-18 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction;
>in 2018-19, 50% finance costs deduction and 50% given as a basic rate tax reduction;
>in 2019-20, 25% finance costs deduction and 75% given as a basic rate tax reduction;
>from 2020-21 all financing costs incurred by a landlord will be given as a basic rate tax reduction.
Here’s a worked example:
Dan owns a mortgaged rental property that he lets to a family. He has a mortgage on the property and he claims the interest on this as an expense against his rental income each year. Dan also has a job where he earns £49,000 per year. The interest on his mortgage is approximately £2,000 per year. Below is a table showing the increase in his tax liability between now and 2020-21:
Extra tax due:
If Dan’s interest and other expenses were not fully covered by his rent then the above position would be worse as he would lose relief entirely on some of the interest.
Withdrawal of Wear & Tear Allowance
From April 2016, the wear and tear allowance will be withdrawn, instead being replaced by a new system that only allows landlords tax relief when they replace furnishings.
This will simultaneously increase the record keeping requirements placed on the landlord and, in many cases, increase their tax liability too.
Wear & tear allowance was designed as a blanket relief to cover costs such as:
>movable furniture or furnishings, such as beds or suites;
>Fridges and freezers;
>Carpets and floor coverings;
>Crockery or cutlery.
It is calculated at 10% of net rents (we won’t explore the definition of net rents here). So as an example:
Dan receives £10,000 of rent per year from his tenants. He has opted to claim the wear & tear allowance and, consequently, is entitled to a £1,000 deduction against his rents. If he is a higher rate taxpayer then this will lead to a £400 reduction to his tax bill.
Under the new system, he will not be able to claim this flat rate deduction and, instead, will only be able to claim for actual costs incurred. So, if in the example above, he had purchased a new mattress in the year for £150, he would be entitled to tax relief only on this amount. In this example, it would reduce the tax relief available and increase his tax bill for the year by £340.
Of course, if Dan had spent more than £1,000 on items for his property he would be better off under the new system. In our experience, though, in most scenarios the wear & tear allowance generally exceeds the actual expenditure incurred by the landlord.
It should be mentioned that the new rules to replace wear & tear allowance are still under consultation and we don’t know exactly what will replace it yet.
It is likely that many clients will be affected by both of the changes detailed above and may face significant increases in their tax bills over the coming years. Clients are advised to review their property holdings and look for planning opportunities to mitigate the impact of the above.