How does the new restriction of tax relief on finance costs work?

The Finance Act 2015 introduced changes to the way tax relief on expenditure on finance costs in respect of the letting of residential property. 

Relief for finance costs will be given as a basic rate tax reduction. This means that only 20% of the total costs incurred will be relieved against the overall tax liability. Total costs will not be used to reduce the income received from the letting of property.

When does this come into force?

The new rules will gradually come into force from April 2017 and be finally in place from April 2020.

How is the relief calculated?

2017/18 - 75% of the total finance cost will be set against the income received (in the same way as 2016/17).

                25% will be used as a basic rate tax reduction

In terms of the finance cost restrictions, the HMRC guidance document confirms the limitations are:

Individuals will be able to claim a basic rate tax reduction from their Income Tax liability on the portion of finance costs not deducted in calculating the profit. In practice this tax reduction will be calculated as 20% of the lower of the:

• finance costs not deducted from income in the tax year (25% for 2017 to 2018, 50% for 2018 to 2019, 75% for 2019 to 2020 and 100% thereafter)
• profits of the property business in the tax year
• total income (excluding savings income and dividend income) that exceeds the personal allowance and blind person’s allowance in the tax year

Example 

Income received from letting of property of £7,000 and total finance costs incurred of £3,500.

Income                                                            £7,500

Less finance costs (£3,500 x 75%)                 £2,625

Net assessable income                                  £4,375

Tax due  4,375 x 20%                                    £875.00

Basic rate tax reduction for finance costs

(£3,500 x 25%) x 20%                                 (£175.00)

Net tax due                                                   £700.00