This is a summary of the recent changes in the calculation of rental profits. The three main areas discussed are:
- Replacement of Domestic Items Relief
- Restriction of Finance Costs
- £1,000 Property Allowance
Please be aware that this article is based on current legislation, which is subject to change.
Replacement of Domestic Items Relief
‘Replacement of Domestic Items Relief’ came into effect from 6th April 2016.
It replaced the “Wear and Tear Allowance which was an additional deduction available for furnished property lets and was calculated by taking 10% of your adjusted rental income.
Unlike the Wear and Tear allowance, the ‘Replacement of Domestic Items Relief’ can be applied to both furnished or unfurnished property lets. Relief is given as a deduction against rental income for the replacement of items such as furniture, furnishings, household appliances and kitchenware.
As the name implies, relief can only be claimed if there is a replacement of an existing item. Additional items cannot be deducted as a revenue expense under this relief.
If there is an element of improvement in the replacement item (e.g. replace a sofa with a sofa-bed), then the full cost of the new item will not be deductible. It will be limited to the cost of replacing the original item to the nearest modern equivalent (including any incidental costs in disposing of the original item). Any proceeds obtained from disposing the original item will deduct the relief available.
You cannot claim ‘Replacement of Domestic Items Relief’ for any of the following:
- Furnished holiday lets (1)
- If there is any private use element of the item
- If Rent-a-Room relief is claimed
(1) Furnished holiday lets were also not eligible for the 10% Wear & Tear allowance and instead are able to claim “capital allowances” for revenue expenditure.
Restriction of Finance Costs
The most significant change to the rental profit calculation for the 2017/18 Tax year is the ‘Restriction of Finance Costs’. Previous rules allowed a deduction against rental income for finance costs such as (but not limited to) mortgage interest, overdraft interest and other incidental costs in getting/repaying a mortgage.
By 6th April 2020, financial costs will not be an allowable deduction in determining rental profit.
This will be applicable to UK and Foreign residential property lets. It will not affect commercial properties, furnished holiday lets or companies that own residential property lets.
The restriction is being phased out over three tax years, starting from 6th April 2017 (2017/18) as described in the table below.
Finance costs allowable as a deduction against Rental Income
Rental profits are subject to the taxpayer’s income tax rates (for 2017/18, the rates are 20%, 40% and 45%).
Once the gross tax liability for the year has been calculated, the remaining percentage of your finance costs not used in determining your rental profits could be used to reduce your tax liability. The relief is limited to 20% of the disallowed deduction.
For example, if your finance costs for the 2017/18 tax year were £10,000, £7,500 would be deducted against rental income and 20% of the remaining £2,500 (£500) would be used to reduce your tax liability.
There are restrictions to this relief, the amount you could claim is the lower of:
- Percentage of finance costs not allowable as a deduction (e.g. 25% for 2017/18)
- Property Income for the year after losses brought forward (relief cannot create a loss)
- Adjusted total income after personal allowance.
If the relief is restricted, there is a facility available to carry forward unused deductions to the following tax year.This is a significant change in how rental profits are calculated and is not in the taxpayers’ favour. Landlords’ who also claim child benefits need to be aware that this change could push them above the repayment threshold.
£1,000 Property Allowance
As of 6th April 2017, the £1,000 property allowance has been introduced to simplify income tax obligations for low rental income. It is a £1,000 rental deduction against gross rental income and cannot be used in conjunction with other rental expenses. However, for joint properties, both taxpayers are eligible to claim the £1,000 property allowance.
If the allowance is claimed, actual rental expenses (including the deduction for financial costs) cannot be claimed. It will be beneficial to estimate each year whether actual expenses incurred provides a larger deduction than claiming the property allowance alone.
If the total rental income before expenses for all properties in a tax year are less than or equal to £1,000, full relief is applied so that no tax is due on this income. It is important to note that this allowance cannot create a rental loss. If rental income has been reduced to zero using the Property Allowance, then this will not give rise to a UK Tax Return filing requirement. Individuals already registered for Self-Assessment should continue to file and claim the allowance on their Tax Return.
This allowance is applicable to UK and foreign residential or commercial properties only. It is not available where Rent-a-room relief is claimed or against partnership property income.
This is only a very brief outine of the recent changes. For a more information on the associated issues or if you are a residential landlord and require any assistance regarding your tax affairs; please do not hesitate to contact us.