Finance Restrictions for rental income
It was announced in summer 2015 that rules would be introduced to restrict relief for financial costs on residential properties to the basic rate of income tax. These rules have begun to take effect from the tax year 17-18 onwards and are being phased in over four tax years.
Generally, this means that landlords will no longer be able to deduct finance costs from their property income in the profit computation but will instead receive a basic rate deduction from their tax liability. Whilst this would appear to imply that only higher rate taxpayers would be affected by these changes, a closer look at the legislation in s274AA ITTOIA 2005 shows that the tax reduction a taxpayer is entitled to in a tax year is 20% of the lower of:
- The finance costs not deducted from rental income in the tax year,
- Profits of the property business in the year, and
- The individuals ‘adjusted total income’ (total income, excluding savings and dividends income, in excess of the personal allowance).
Therefore, if a client’s salary and rental profit for the year are covered by their personal allowance, their ‘adjusted total income’ will be nil because dividend income is excluded. This will result in no tax reducer being available for the tax year. The finance costs that have been disallowed in the rental income computation will instead be carried forward for relief in the following years.