Controversial new rules
Since the new rules which will limit tax relief on interest and finance costs for landlords of residential properties were announced in 2015, they’ve been a source of controversy, largely because they are unusually tricky to understand. One point which seems to cause a lot of confusion is how property rental losses will be affected.
Interest – old rules v new rules
Under the rules which apply until 6 April 2017 interest etc. counts as a deductible expense in the same way as any other. If your total expenses exceed your rental income it creates a loss, which is carried forward and used to reduce taxable rental profit (or increase a loss) for later years. From 6 April 2017 25% of interest etc. won’t count as an expense and so can’t be taken into account when working out a loss, but it can be carried forward and used in a different way.
Note. The portion of interest not allowed for 2018/19 increases to 50%, for 2019/20 to 75%, and for 2020/21 and later years, it’s 100%.
Example 1. In 2017/18 Amy receives £9,600 rent from a flat she bought in April 2017. Her expenses are £4,000, plus mortgage interest of £8,000. To arrive at her taxable profit she can deduct the £4,000 and 75% of the mortgage interest (£6,000). The result is a loss of £400 which can be carried forward. The disallowed interest of £2,000 can also be carried forward, but not as a loss; it is instead added to the interest paid in the next year.
Example 2. In 2018/19 Amy received rent of £10,000. Her expenses are £3,800, plus mortgage interest of £7,800. In 2018/19 the proportion of interest which can’t be claimed as an expense is 50%. This means Amy’s rental income profit is £1,900, i.e. income £10,000 less: expenses of £3,800, mortgage interest of £3,900 (being 50% of £7,800) and the loss brought forward of £400. She also has brought forward interest of £2,000. This is added to the disallowed interest for 2018/19 of £3,900. It’s here that things start to get tricky.
Tax credit for interest etc. payments
Amy’s disallowed interest of £5,900 (which is the total of the amounts brought forward from 2017/18 and the amount disallowed for 2018/19) is used to create a tax credit, which is knocked off her general tax liability. The maximum credit is the basic tax rate (20%) multiplied by the interest, i.e. £1,180 (£5,900 x 20%), but further restrictions can apply. These limit the tax credit to the lower of 20% of the:
- disallowed finance costs, in Amy’s case that’s 20% of £5,900
- property profits, i.e. for Amy that’s 20% of £1,900; and
- adjusted total income. We haven’t given figures in our examples to work this out for Amy – there are too many variables which can affect the result, so we’ll look at this in another article.
Any part of the disallowed interest that isn’t used to create a credit can be carried forward and used the next year.
Tip. While you should already be keeping a record of losses carried forward because they must be declared on your tax return, for 2017/18 and later years you’ll also need to report the amount of carried forward interest (if any), so it’s important to understand how the new rules work.
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