HMRC treats the letting of property as a business which means that landlords are taxed on their profit after offsetting expenses relating wholly and exclusively to the business.
Prior to April 2017 expenses which could be claimed included finance costs (such as interest payable) on loans applied for the purposes of the business (usually to purchase the property). Repayments of capital cannot be deducted which is why many buy-to-let mortgages are ‘interest only’.
However, since April 2020 landlords have been unable to deduct any part of their finance costs. Instead, they receive a basic rate (20%) reduction from their income tax liability for those costs. The effect is to restrict the tax relief available for finance costs to 20%. For basic rate taxpayers, there is little tax impact but for higher or additional rate taxpayers it means that they are paying an additional 20% or 25% tax on profits which would have previously been offset by finance charges. For highly geared businesses, this has a significant impact.
Let’s take the example of a higher rate taxpayer with and investment property generating monthly rental income of £3,000 net of expenses other than finance charges. If the taxpayer is paying monthly loan interest of £1,500 per month, prior to April 2017 they would have had an annual tax liability on their rental income of £7,200. In the current tax year (2023/24) it would be £10,800.
Selling rental property
As fixed rate mortgages expire and need to be remortgaged at higher interest rates, many landlords are reconsidering the viability of their letting businesses and are taking the decision to sell their property(s).
Capital Gains Tax (CGT) applies to the profit made from the sale of a rental property. The amount of CGT you owe is determined by the difference between the property's sale price and its original purchase price, with some adjustments for various costs and improvements, as well as an exemption for any time the property was used as the owner’s main residence.
For individuals, the tax rate depends on their total taxable income and other capital gains. Basic rate taxpayers pay 18% on their residential property gains, while higher and additional rate taxpayers pay 28%.
Companies and rental properties
The restrictions on tax relief for finance charges do not apply to companies and together with the fact that corporation tax rates are lower than the higher rate of income tax, the use of a company to acquire investment property can be advantageous. However, this is not a silver bullet and each case would need to be considered on its own merit.
Contact Us
Please contact us to find out how the above applies in your circumstances and how you can reduce your tax liabilities and maximise your tax efficiency.
Please note that the above is for general information only and does not constitute financial or tax advice. You should not rely on this information to make or refrain from making any decisions. You should always obtain independent professional advice in respect of your own situation.
