If you are a buy to let landlord, you will almost certainly be aware that the restriction on tax relief for finance costs started to bite from 6 April this year.
For the current tax year, only 25% of finance costs are subject to the basic rate restriction. For example, if your buy to let finance costs are £20,000, then £15,000 can be deducted as an expense in calculating property income. Tax relief for the other £5,000 will be given as a basic rate tax reduction of £1,000 (£5,000 at 20%) against your income tax bill. So if you are a higher rate taxpayer and your rental income is, say, £30,000, this will push your tax bill on property income up to £5,000 from the previous £4,000.
By 2020/21, when 100% of finance costs are subject to the restriction, the tax bill in this example will have gone up to £8,000. Profit, after taking account of tax, will then be just £2,000, compared with £6,000 before the introduction of the restriction. What’s more, property income will have risen from £10,000 to £30,000, which might lead to other tax implications.
The finance costs that are restricted do not just include mortgage interest but also interest on loans used to furnish or renovate a property, overdrafts, and fees and other incidental costs of obtaining or repaying finance. The restrictions apply to UK residents who own overseas properties.
New buy to lets
For new buy to lets, using a limited company will bypass the restriction, although there are other important tax issues to consider before going down this route. As for incorporating an existing property business, this might be an option if you have not owned the property for too long – otherwise the capital gains tax (CGT) cost could be excessive. And don’t forget the stamp duty land tax cost, with the additional 3% rate applicable.
Another option might be to sell off some properties in order to pay off some or all of the finance on the ones you retain. Although there will be the CGT cost, you might find yourself having to do this anyway if you cannot re-mortgage in the future because of the tighter lending restrictions that now apply. Replacing buy to let finance with a mortgage on your own home is also a possibility given that residential mortgage rates are generally much lower. The interest should still qualify for tax relief.