For the tax year to 5th April 2019 we have the second of four increases in the interest restriction that affects residential landlords. This phased measure particularly impacts those with relatively high levels of debt on their buy to let properties. The restriction does not apply to furnished holiday lets.
The broad objective of this tax measure is to restrict tax relief on buy to let mortgage interest to the 20% basic rate tax. HMRC’s guidance can be found at https://www.gov.uk/guidance/changes-to-tax-relief-for-residential-landlords-how-its-worked-out-including-case-studies
A common misunderstanding is that the restriction only affects higher rate tax payers, some basic rate taxpayers will have an increased tax charge as well. Higher rate taxpayers also face additional traps. Over and above the interest tax relief drop from 40% to 20%, higher rate payers could suffer a high income child benefit charge; a loss of personal allowance; a loss of pension tax relief; a move into the additional rate tax band.
The reason the measure can be much more costly than expected is because of the way the restriction applies. The restriction has two steps (summarised below) and it is step 1 that can push a basic rate payer into higher rate tax, or adversely affect a higher rate taxpayer over and above the reduction of interest relief.
Step 1 - Disallow the Interest Cost. This has the effect of increasing profits subject tax and potentially pushing the tax payer into a higher effective rate of tax.
Step 2 – Reduce the tax bill by the Interest cost x 20%. Importantly this step does not reduce the profit figure on which tax is calculated.
For taxpayers adversely affected by the measure a careful appraisal of the individual’s tax position and all the options is recommended. This would include looking at ways to reduce the debt on personal buy to let properties, and obtaining professional advice on operating the property letting business through a limited company.