The tax relief for loan interest and other financial expenses that relates to to-let residential properties will be restricted from April 6th 2017. As a result of this, your current and future losses from your buy-to-let property will be affected. Here’s how…
The New Controversial Rules
Since 2015 (when new rules limiting tax relief on finance costs and interest for landlords of residential properties were implemented), there have been lots of controversies around the subject due to individuals struggling to understand them. A lot of people still do not understand how property rental losses will be affected.
Old and New Interest Rules
These rules still apply up until the 6th of April. Interest will still count as a deductible expense in the same way as any other expense and if your total expenses exceeds your rental income, a loss will be created. This loss is then carried forward to reduce taxable rental profit (or increase a loss) in the future.
After the 6th of April, 25% of interest won’t count as an expense therefore cannot be considered when working out a loss. However it can be carried forward and used in a different way. Also, interest portions not allowed for 2018/19 will increase from 50%, for 2019/20 to 75%, and for 2020/21 and later years, it will increase to 100%.
For example – In 2017/18 Cara receives £9,600 rent from a flat she bought in April 2017. Her expenses are £4,000, plus mortgage interest of £8,000. To arrive at her taxable profit, she can deduct the £4,000 and 75% of the mortgage interest (£6,000). This result in a loss of £400 which can be carried forward and the disallowed interest of £2,000 can also be carried forward, but not as a loss; it is instead added to the interest paid in the next year.
Tax credit for interest etc. payments
Cara’s disallowed interest of £5,900 (which is the total of the amounts brought forward from 2017/18 and the amount disallowed for 2018/19) is used to create a tax credit, which is deducted from her general tax liability. The maximum credit is the basic tax rate (which is 20%) multiplied by the interest, i.e. £1,180 (£5,900 x 20%), however, further restrictions may apply. These limit the tax credit to the lower of 20% of the: disallowed finance costs, property profits, adjusted total income.
Any part of the disallowed interest that isn’t used to create a credit can be carried forward and used the following year.
Remember: you should already be keeping a record of losses carried forward because they must be declared on your tax return for 2017/18 and in later years you’ll also need to report the amount of interest carried forward (if any exists). Therefore, understanding the new rules and how they work is extremely important.
To summarise, from 6 April 2017 a portion of loan interest etc. (25% for 2017/18 rising to 100% by 201/21) won’t count as tax deductible and so cannot create a loss. The non-deductible interest is allowed as a basic rate tax credit instead. If not all the interest can be used this way, it’s carried forward to use as a credit in the future.