At the moment, full tax relief is available for interest paid on a loan which is used in a property business. This might be interest on the actual mortgage, or interest on a loan to finance repairs etc.
From April 2017 (so not immediately!) tax relief on this interest will start to be restricted. By 2020, loan interest will not be an allowable expense when calculated the profits of the business, but will instead attract tax relief restricted to 20%.
If the property owner is only a basic rate taxpayer anyway, the net effect of these changes is zero. The problem comes where the taxpayer is in the higher or additional rate bands. An example is necessary to show how this will work:
Boris has a full time job and is a 40% taxpayer. As well as owning his own family home, he also owns a flat which he is renting out. He has an interest-only mortgage on this property of £100k at 5%. The comparison between the current rules and year 2020-21 when the changes are fully phased in is as follows:
Tax Year 16-17 20-21
Gross rents 9,600 9,600
Costs (e.g. repairs) (1,500) (1,500)
Loan Interest (5,000) -
Rental Profits 3,100 8,100
Tax at 40% 1,240 3,240
Less interest relief (1,000)
@20% on 5,000
Net tax liability 1,240 2,240
Effective tax rate
On actual profit 40% 72%
Cash after tax 1,860 860
This change to taxation evidently adversely affects the expected yield on a property business. For let properties where the loan value (and hence interest paid) is relatively low, the changes might be manageable; for larger property businesses using debt to increase the portfolio, their business model now becomes unsustainable. Possible solutions include transferring properties and loans into a corporate structure, paying down loans or selling up entirely!
If you are adversely affected by these impending changes, please talk to us to calculate what this actually means for you.