According to HM Revenue & Customs’ (HMRC) policy paper, ‘Restricting Financial Cost Relief for Individual Landlords’ it’s not just mortgage interest to which the change in tax relief applies. As well as mortgage interest, finance costs include interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans. The changes do also apply to mortgage arrangement, booking and valuation fees.
However, tax relief won’t be fully restricted to the basic rate of 20% until the 2020-21 tax year. Until the 2017-18 tax year – which is the tax year after next – individual landlords will still be able to deduct all finance costs from their rental income to arrive at the amount on which they have to pay tax. For a 40% taxpayer with yearly rental income of £9,600 and annual finance costs of £6,000, this would mean a tax bill on the rental income of £1,440.
The gradual reduction of tax relief starts in the 2017-18 tax year. At this point the amount of finance costs landlords are able to deduct from rental income goes down to 75%. But in addition, they will be able to subtract tax relief at 20% on the remaining 25% of finance costs from the amount of tax payable which, given the same scenario as before, would mean a tax bill of £1,740.
In the 2018-19 tax year, the finance cost deduction goes down to 50% with 50% given as a basic-rate tax reduction resulting in a tax bill of £2,040. In the 2019-20 tax year the figures are 25% deduction, basic-rate relief on 75% of finance costs and a tax bill of £2,340. When fully basic-rate restricted tax relief comes into force, the equivalent tax bill would be £2,640, which is £1,200 more than under the current system.
Landlords may be relieved to hear that if you file a self-assessment tax return online, the new tax calculations will be automated so you won’t have to do the sums yourself. If you fill in a paper return, there will be a tax calculator to help you with the figures. Another change, which is happening much sooner, is the removal of the 10% wear and tear allowance. Irrespective of whether they have spent money on repairing or replacing furnishings, this currently allows landlords to reduce the amount of tax they pay by deducting the allowance – which is equal to 10% of their annual rental income – from their rental income to arrive at the amount of income on which they pay tax.
From 6 April 2016, the notional wear and tear allowance will be replaced by a new relief that only allows landlords to deduct actual costs of repairing or replacing furnishings.