There have been a few blows to landlords in the tax legislation over the last year or so. Increased costs and reduced tax relief mean that your rental income is not going to be as profitable as it once was.

Stamp Duty increase – from April 2016 an extra 3% stamp duty is payable on buy-to-let property purchases.

Wear and Tear Allowance – the standard 10% deduction that was allowed each year on furnished properties is no longer available from April 2016. However, you can claim relief on your actual expenditure.

The biggest change is the cut in the relief on your finance costs. This isn’t just your mortgage interest but any finance costs related to the property, such as loans to buy furnishings.

You can currently claim the interest as an expense and deduct if from your income to give a net profit (or loss) which is taxable. The relief is now to be restricted to 20% of the finance costs, which will be deducted from your income tax liability. This is going to be phased in over 4 years as follows:

  • 2017/18 – 75% of the expense is deducted as normal, 25% restricted to 20%
  • 2017/18 – 50% of the expense is deducted as normal, 50% restricted to 20%
  • 2017/18 – 25% of the expense is deducted as normal, 75% restricted to 20%
  • 2017/18 – 100% restricted to 20%

This will mainly impact higher and additional rate tax payers but if you are a basic rate tax payer who is close to the higher rate band, you may be pushed into higher rate, as the following example shows. (The example uses the 2016/17 tax bands and rates just as a guide, but as shown above the changes will not be introduced until 2017/18):

Current Rules New Rules
Salary 35,000.00 35,000.00
Rental Income 9,600.00 9,600.00
Less interest
7,600.00 9,600.00
42,600.00 44,600.00
PA – 11,000.00 – 11,000.00
31,600.00 33,600.00
Tax @ 20% 31600 x 20% 6,320.00 32000 x 20% 6,400.00
Tax @ 40% 1600 x 40% 640.00
6,320.00 7,040.00
20% tax deduction -400.00
6,320.00 6,640.00

The tax deduction that is allowed is 20% of the lower of:

  • Finance costs not deducted from income
  • Profits of property business
  • Total income (excluding savings and dividends) that exceeds personal allowance.

If the profits of the business are lower than the finance costs, and therefore the 20% deduction is based on this figure, any excess finance costs can be carried forward to the following years.