Following the 2015 Summer Budget, there are some changes being brought into force for buy-to-let owners. Read on to find out how the new rules will affect you…
Heard the news? Income tax relief for landlords on residential property finance costs is to be restricted to the basic rate of income tax. Plus, there will be no relief for the capital repayments of a mortgage or loan.
What does this mean for you?
In a nutshell, you will no longer be able to deduct all of your finance costs from your property income. Instead, you will receive a basic-rate deduction from your income tax liability for your finance costs.
To give you time to get to grips with the change, the Government will introduce the new set-up over a 4-year period, from April 2017. From 2012/21, all the financing costs you incur, as a landlord, will be given as a basic-rate tax reduction.
Just so you know, the restriction relates to finance costs, not just interest, so relief for a lender’s fees will also be restricted. For landlords of furnished holiday lettings, the restriction will not apply.
How much extra tax will you pay?
This will depend on your marginal rate of tax and the amount of interest you pay. Basic-rate taxpayer? You will not see a substantial increase on your bill. If you are a higher-rate taxpayer, you will, in principle, get a 20% relief for interest paid, rather than paying 40%. So, for example, if the interest paid is £10,000 per year, the extra tax liability will be £2,000 ie £10,000 x (40% – 20%).
The full restriction will not be in place until 2020/21. In 2017/18, the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% being available as a basic-rate reduction. So, if the interest paid is £10,000 per year, the extra tax liability in 2017/18 will arise on £2,500 of the interest only. This will result in an extra tax liability of £500 i.e. £2,500 x (40% – 20%).
There might be some steps you can put in place to improve your position once the new changes come into play.
The restriction on interest relief does not apply to companies. Therefore, you could consider owning properties through a limited company. However, there are a number of issues you will need to think about before doing this.
If you are thinking about making new investments in residential properties without using a company, you need to consider the lack of full tax relief in the long term when calculating the viability of any project.
Wave goodbye to the Wear and Tear allowance
Many businesses receive capital allowances to recognise the depreciation of equipment they use. However, there are no capital allowances due for equipment bought for use in a residential property.
There are exceptions to this rule for property, meeting the definition of a furnished holiday letting and expenditure on assets, which are used in the non-residential part of a block of flats – in the hallways, for example.
Since April 2013, a taxpayer letting a fully furnished residential property could only claim a deduction of 10% of the ‘net rent’ for wear and tear. This was to cover the depreciation of equipment.
Additionally, from the same date where a dwelling is let partly furnished, there are no allowances unless costs are incurred on equipment and can be classified as a repair. Relief will then be given for these costs. In some cases, a repair will include the replacement of that item if it is a ‘fixture’ in the building.
Whether expenditure is a repair can be complex, and is governed by principles established in a number of tax cases.
From April 2016, the Government is proposing to remove the Wear and Tear allowance. A new relief will allow all residential landlords – in respect of a fully furnished dwelling or not – to deduct the actual costs of replacing furnishings provided for the tenant’s use in the residential property. The initial cost of furnishing a property will not be included.
Capital allowances will continue to apply for landlords of furnished holiday lettings.
Replacement furniture eligible for the new relief
If you are a landlord of unfurnished, part-furnished or furnished properties – but not furnished holiday lets – you can claim the relief. You will be able to claim a deduction for the capital cost of replacing furniture, furnishings, appliances and kitchenware provided for the tenant’s use in the house, so things like…
- Movable furniture or furnishings, such as beds or suites
- Fridges and freezers
- Carpets and floor-coverings
- Crockery or cutlery
- Beds and other furniture.
Repair expenditure – fixtures eligible for the new relief
If a property is sold, the owner does not normally remove fixtures integral to a residential home. The replacement cost of these is, and will continue to be, a deductible expense as a repair to the property itself. Fixtures include items such as…
- Fitted kitchen units.
A step ahead
The Wear and Tear Allowance is given whether or not you have replaced any furnishings. From 6th April 2016 – or 1st April 2016 for companies – specific relief will be given for these costs, so it makes sense, if possible, to defer replacement expenditure until after these dates.
A similar point applies if you let out a property that is only partly furnished. No relief is given at the moment for replacing furnishings, but relief will be given for such expenditure from April 2016.