​Interest relief for landlords – the next stage

04-May-2018

The way in which landlords can obtain relief for interest payments and other finance costs is moving gradually from relief by deduction to relief as a basic rate tax reduction. Where the landlord pays tax at a rate above the basic rate, the value of that relief will gradually reduce.

The change is being phased in over four years. The process began in 2017/18 with a move from full relief as a deduction in calculating taxable profits to a hybrid situation whereby relief for 75% of the interest costs is given as a deduction in calculating taxable profits and the remaining 25% as a basic rate tax deduction. Landlords will need to use the new rules when working out their taxable profits for 2017/18.

The start of the 2018/19 tax year brings with it the next phase of the shift - for 2018/19, landlords will receive relief for 50% of their interest costs as a deduction and the remaining 50% as a basic rate reduction.

The following case study shows what impact this change has on a particular landlord.

Case study

Raj has two investment properties that he lets out. He also works in IT, earning a salary of £50,000. He pays tax on his rental profits at 40%.

In 2017/18 and 2018/19, his rental income is £25,000. He has interest costs of £10,000 and other expenses of £3,000.

In 2017/18, he can deduct £7,500 (75% of £10,000) in calculating his rental profit. Relief for the remaining £2,500 is given as basic rate tax reduction of £500 (£2,500 @ 20%).

In 2018/19, he can deduct £5,000 (50% of £10,000) in calculating his rental profit. Relief for the remaining £5,000 is given as a basic rate tax reduction of £1,000 (£5,000 @ 20%).

The tax payable for each year is calculated as follows

  2017/18 2018/19
  £ £ £ £
Rental income   25,000   25,000
Expenses (3,000)   (3,000)  
Interest deduction (7,500)   (5,000)  
    (10,500)   (8,000)
Taxable rental profit   14,500   17,000
Tax @ 40% 5,800   6,800  
Basic rate tax reduction (500)   (1,000)  
Tax   (5,300)   (5,800)

 

The profits retained by Raj for each year are as follows:

 

  2017/18 2018/19
  £ £
Rental income        25,000        25,000
Interest costs (10,000) (10,000)
Other expenses (3,000) (3,000)
Tax (5,300) (5,800)
RETAINED 6,700 6,200

 

As a result of the shift, Raj gets to keep £500 less of his rental income in 2018/19 than in 2017/18, despite the fact that nothing has changed.

Looking ahead

The shift continues in 2019/20. For that year, relief for 25% of interest costs will be given by deduction and the remaining 75% as a basic rate tax reduction. From 2020/21 onwards, relief will only be available as a basic rate tax deduction.