Since 2017, a restriction on the tax relief available for finance costs for individual landlords has been gradually phased in, having full effect from 6 April 2020 onwards. With many low-interest rate mortgages coming to an end, landlords are at risk of a potentially significant tax increase.
Rather than a deduction for mortgage interest and other finance costs being available in calculating the profits subject to income tax, tax is now calculated on the profits without any deduction for finance costs (at the usual 20%, 40% or 45% rates), then a reduction to the calculated liability is allowed for 20% of the finance costs. This is regardless of the rate at which income tax is payable.
This can result in taxpayers who had previously been only basic rate taxpayers having an unexpected large increase in their income tax liability. For example, assume an individual has rental income of £80,000 and finance costs of £50,000, i.e., a pre-tax profit of £30,000:
- Under the old rules, they would simply pay income tax of £30,000@20% = £5,000.
- Under the new rules, their income tax liability is calculated on £80,000, as (£50,270@20%) + (£29,730@40%) = £21,946. A ‘tax reducer’ is then calculated for their finance costs at 20%, i.e., £50,000@20% = £10,000, leaving them with a final liability of £11,946, £6,946 greater than before.
Where typical planning strategies such as increased pension contributions are insufficient to achieve an acceptable tax position, incorporation may provide a possible solution, but can be costly. If you would like to discuss the impact on your specific circumstances, please get in touch with your usual DSG contact.
