Restriction for finance costs on residential properties (except, furnished holiday letting and company) to the basic rate of Income Tax. (Finance costs include mortgage interest, interest on loans to buy furnishings and fees incurred). This was introduced gradually from 6 April 2017 to 5 April 2020. The only part of the loan interest eligible for relief is allowable as a deduction from income when calculating taxable property income in respect of residential properties.
Amount of interest allowable as a deduction in previous three years:
From 2020/21 no relief for loan interest will be given as a deduction from income in respect of residential property. Instead, interest is only eligible for basic rate tax relief.
Relief at basic rate (20%) is available on lower of:
If any amount of eligible interest has not received relief, is carried forward to the next year and is added to the amount of interest for that year.
Effect on taxpayer:
Basic rate taxpayer:
Higher or Additional rate taxpayer:
It is possible that the overall effective rate of tax on the ‘real’ profit from the letting could be more than 100%, when the full amount of eligible loan interest only obtains relief at the basic rate.
Mr X is a 40% (higher rate) taxpayer, he has a two-bedroom rental property in London. He received rent £15,000 per year. In 2020-21 he paid repairs and other allowable expenses £2,000 and mortgage interest paid £10,000.
So, Mr X’s Real profit from the property is £3,000 (£15,000-£2,000-£10,000).
For tax purpose, he makes a rental profit in 2020/21 of £13,000 (£15000-£2000).
Tax: 13,000 @40% £5,200
Less: Relief on finance cost 10,000 @20% £2,000
Mr X’s tax bill will be £3,200, which is higher than the real profit of £3,000. Which means Mr X ends up paying tax £200 from his own pocket NOT from the profit. So, (in some cases) an effective rate of tax (3200/3000)100% = 106.6%!
NAZALI TAX & LEGAL