Currently, interest on a loan used to purchase a buy-to-let property, can be deducted from the rental income received.
However landlords were dealt a blow in the 2015 budget when the Government decided to change this longstanding rule. In future, instead of the whole interest being deducted from rental income before the profit is taxed, the individual will only be allowed a basic rate tax deduction of 20 percent of the interest paid (this does not apply to owners of furnished holiday accommodation).
The change is effective from April 2017 and will be phased in over a four year period with transitional rules until April 2020. During these four years the amount of tax deduction from the rental income will reduce and the proportion of loan interest that will only qualify for basic rate tax relief will increase.
See also: Letting a Property
The relief that will be allowable over the transitional years will be:
• 2016/17 – 100 percent of the interest against the rental income
• 2017/18 – 75 percent of the interest against the rental income, 25 percent of the interest at basic rate tax relief
• 2018/19 – 50 percent of the interest against the rental income, 50 percent of the interest at basic rate tax relief
• 2019/20 – 25 percent of the interest against the rental income, 75 percent of the interest at basic rate tax relief
• 2020/21 – 100 percent of the interest is at basic rate tax relief
These changes could significantly affect higher rate taxpayers and the following example shows how they will be affected:
Tom has rental income of £20,000 per year and is a 40 percent tax payer. He pays interest on his loan of £4,000 per annum. Ignoring any other expenses allowable and just looking at the interest implications, tax would be due as follows:
| Tom | 2016/17 | 2017/18 | 2018/19 | 2019/20 | 2020/21 |
| Rental Income | £20,000 | £20,000 | £20,000 | £20,000 | £20,000 |
| Less interest | (£4,000) | (£3,000) | (£2,000) | (£1,000) | (£0) |
| Profit | £16,000 | £17,000 | £18,000 | £19,000 | £20,000 |
| Tax @ 40 percent | £6,400 | £6,800 | £7,200 | £7,600 | £8,000 |
| Basic rate relief on loan interest | £0 | (£200) | (£400) | (£600) | (£800) |
| Total tax due | £6,400 | £6,600 | £6,800 | £7,000 | £7,200 |
These calculations assume that personal allowance has been utilised against other income.
These changes coupled with the additional three percent stamp duty on buy to let properties and the abolition of the 10 percent wear and tear allowance are all likely to hit landlord’s hard. Larger buy-to-let property investors who use debt to expand their portfolios will be especially affected, as their business models will be seriously undermined.
TWD Accountants offer a fixed fee tax and accountancy service for landlords and can offer advice and guidance on any queries you may have. For more information contact them on 0800 093 9433.
See also: Getting Started as a Landlord
