Buy to Let Residential Property – Changes to Interest Relief

The Chancellor announced in the July 2015 Budget that higher rate tax relief on mortgage interest payments by individual buy-to-let landlords of residential property (and partnerships of individuals that are landlords) would be gradually withdrawn. Instead of treating the interest as a deduction in calculating net taxable property income, a landlord will claim basic rate relief as a reduction of his tax liability.

The restriction will not apply to the interest relating to properties that qualify as furnished holiday lettings.

Effect of changes

For 2016/17 and earlier tax years, 100% of the mortgage interest paid is allowed as a deduction from property income.

However, from 6 April 2017 onwards the amount of interest paid that will be allowed as a deduction in calculating profits will reduce as follows:

• for 2017/18, 75% of the interest will be allowable;
• for 2018/19, 50% of the interest will be allowable;
• for 2019/20, 25% of the interest will be allowable;
• for 2020/21 and subsequent years, 0% of the interest will be allowable.

For each of these years, and for subsequent years, the % of the interest not allowed as a deduction in calculating profits will be given as a basic rate reduction from the tax due on the rental income.

When considering the likely return on an investment, a landlord who is a higher rate taxpayer must factor in the unrelieved mortgage interest as an additional cost

An example of the impact of the changes for a higher rate taxpayer is shown below.

As a result of these changes it may be more attractive to own residential investment properties through a company.

The advantages of operating through a company include:

• relief is available for all interest paid;
• corporation tax at 20% is payable on income and gains;
• income can be accumulated in the company for distribution at a time when the shareholders are basic rate taxpayers;
• the first £5,000 of dividend income for each shareholder is taxable at 0%.

However, there can be significant costs involved in incorporating an existing residential property business – such as capital gains tax, stamp duty land tax/land and buildings transaction tax, and bank/finance costs to move the debt across to a new company.   

Example of impact of changes for a higher rate taxpayer

John has borrowed £250,000 at a rate of 4%.