Landlords and Finance Costs Restriction: What’s Deductible Now?

Written on 29 April 2019 by Robyn Clark


Landlords and Finance Costs Restriction: What’s Deductible Now?

Section 24 of the Finance Act 2015 stated that the amount private residential landlords could deduct from their rental income in finance costs would be phased out from 2017 and replaced with a relief at the basic rate of 20%.

Before April 2017, landlords could reduce the amount of Income Tax they paid by deducting certain finance costs from their rental income, like mortgage interest payments.

In this blog we’ll explain what Section 24 is, how it really affects the amount you’ll pay, how far through the phasing out process we are and what exactly counts as a finance cost.

Section 24 and How It Changes Tax for Landlords

Below is the legislation in Section 24 of the Finance Act 2015:

Restricting deductions for finance costs related to residential property

  1. Where a deduction is allowed for costs of a dwelling-related loan in calculating the profits of a property business for the tax year 2017-2018, the amount allowed to be deducted in respect of those costs in calculating those profits for Income Tax purposes is 75% of what would be allowed apart from this section
  2. Where a deduction is allowed for costs of a dwelling-related loan in calculating the profits of a property business for the tax year 2018-2019, the amount allowed to be deducted in respect of those costs in calculating those profits for Income Tax purposes is 50% of what would be allowed apart from this section
  3. Where a deduction is allowed for costs of a dwelling-related loan in calculating the profits of a property business for the tax year 2019-2020, the amount allowed to be deducted in respect of those costs in calculating those profits for Income Tax purposes is 25% of what would be allowed apart from this section
  4. In calculating the profits of a property business for Income Tax purposes for the tax year 2020-2021 or any subsequent tax year, no deduction is allowed for costs of a dwelling-related loan

What Does This Mean?

Before we break down how the phasing out works, let’s explain what the end result will be.

From April 2020, landlords will no longer be able to deduct any finance costs from rental income; finance costs will be taxed at your Income Tax threshold.

However, the government have introduced a basic rate relief of 20% on finance costs, in place of the ability to deduct - the same as the basic rate tax threshold. You’ll be able to deduct 20% of your finance costs from the total amount of Income Tax you would otherwise pay. This means that anyone who pays Income Tax at the higher rate thresholds of 40% or 45% will have to pay more tax, but those already paying Income tax at 20% won’t be affected.

Example

This example is based on the tax year April 2020-2021.

  • You’re a higher rate tax payer, so you pay Income Tax at 40%
  • You earn £15,000 in rental income
  • £10,800 goes towards finance costs
  • As you can’t deduct any of your finance costs from your rental income, your Income Tax rate is applied to the full £15,000 of your rental income
    • 40% of £15,000 = £6,000
  • You receive the Allowable Tax Relief which stands at 20%
  • The Allowable Tax Relief is applied to your finance costs, not your total rental income
    • 20% of £10,800 = £2,160
  • The amount you can claim in Allowable Relief is subtracted from the total amount of Income Tax you would otherwise pay on your rental income
    • £6,000 - £2,160 = £3,840
  • You pay £3,840 in Income Tax on your rental income

How It Works at the Moment

For the tax year 2019-2020, landlords can deduct 25% of their finance costs from their rental income when working out their Income Tax – which means they don’t pay any tax on this 25%. They pay Income Tax at their tax band rate on the remaining 75% of their finance costs, as it’s considered part of their taxable rental income.

Example

This is example is for the tax year 2019-2020.

  • You’re a higher rate tax payer, so you pay Income Tax at 40%
  • You earn £15,000 in rental income
  • £10,800 goes towards finance costs
  • You can deduct 25% of your finance costs payment from your rental income
    • 25% of £10,800 = £2,700
    • £15,000 - £2,700 = £12,300
  • Your Income Tax rate is applied to your remaining rental income
    • 40% of £12,300 = £4,920
  • You receive Allowable Tax Relief at 20% on the remaining 75% of finance costs
    • 75% of £10,800 = £8,100
    • 20% of £8,100 = £1,620
  • The amount you can claim in Allowable Tax Relief is subtracted from the total amount of Income Tax you would otherwise pay on your rental income
    • £4,920 - £1,620 = £3,300
  • You pay £3,300 in Income Tax on your rental income

What Counts as a Finance Cost?

The finances costs restriction includes:

  • Mortgage interest payments
  • Interest on loans to buy furnishings
  • Overdrafts

Other costs affected are:

  • Alternative financial returns
  • Fees and other incidental costs involved in taking out or repaying mortgages and loans
  • Discounts, premiums and disguised interest

Who Will Section 24 Affect?

The finance cost restriction will affect:

  • UK resident individuals that let residential properties in the UK or overseas
  • Non-UK resident individuals who let residential properties in the UK
  • Individuals who let residential properties in partnership
  • Trustee or beneficiary of trusts that a liable for Income Tax on property profits

Does This Apply to Limited Companies?

If you want to purchase a buy-to-let through a limited company, then you don’t need to worry about the finance costs restriction as you don’t pay Income Tax on the rental income you’ll receive. You’ll pay Corporation Tax which stands at 19% (2019-2020) and is due to fall to 17% in April 2020.

Other Landlord Tax Changes

See our guide for more information on Buy-to-Let Tax changes.

If you’re interest in taking out a buy-to-let mortgage, call us on 0344 346 3672 or make an enquiry. Or, use our tool to look at some of the best buy-to-let mortgage rates on the market right now.

We always recommend that you seek tax advice from a qualified accountant or tax adviser.

Categories: Buy-to-Let Mortgages, Robyn Clark

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