There are various changes for landlords to get to grips with when preparing their 2016/17 tax returns and for 2017/18 onwards. It is likely, as was the Government's intention, that many landlords will be affected by these changes and may face pressure to their bottom line as their tax bill increases over the coming years. In light of this, now is a good time for property owners to take stock and look for planning opportunities to mitigate the impact and arrange their portfolio in the most efficient way.

This article looks at four key changes:

  • abolition of the 'wear and tear' allowance from April 2016 (relevant for completion of 2016/17 tax returns)
  • restriction of finance costs, such as mortgage interest, to the basic rate of income tax (20%) – this will be phased in from 6 April 2017, to be fully in place from 6 April 2020
  • as announced in Budget 2016, a new property and trading income allowance from 2017/18
  • introduction of Making Tax Digital (MTD) – many landlords will be expected to keep digital records and provide quarterly updates to HMRC from April 2018, or April 2019 if turnover is below the VAT threshold

Abolition of 'wear and tear' allowance

HMRC has abolished the 'wear and tear' allowance for furnished residential properties from April 2016 and has replaced it with 'replacement of domestic items' relief. The new relief will therefore be relevant for landlords completing their 2016/17 tax returns, which are due to be submitted to HMRC by 31 January 2018.

The 'replacement of domestic items' relief will be available for all landlords who let a dwelling house (including flats, apartments etc.) and this includes both furnished and unfurnished properties. This is unlike the wear and tear relief, which only applied to fully furnished properties.

There are certain conditions surrounding the 'replacement of domestic items' relief – please contact our tax team who will be able to provide more information and advise on how the relief works in practice.

Property finance restriction from 6 April 2017

These changes will be introduced gradually over four years from April 2017 and will affect all residential landlords with finance costs. However, only some will have an increased tax liability. The new rules apply to landlords who let residential property as individuals, or in a partnership or trust. Companies and furnished holiday lettings businesses are not affected.

Rather than receiving a full deduction for finance costs, such as mortgage interest (as was the case previously), finance costs will now be disregarded when calculating taxable profits and a basic rate 'tax reduction' will be applied to the individual's income tax liability instead.

The following table illustrates how the restriction will be phased in from 6 April 2017, to be fully implemented by 2020/21:

Tax year

Percentage of finance costs deductible from rental income

Percentage of basic rate tax reduction

2017 to 2018

75%

25%

2018 to 2019

50%

50%

2019 to 2020

25%

75%

2020 to 2021

0%

100%

Because the effect of the new rules is merely to restrict tax relief to the basic rate of tax, it is easy to think that this will not affect basic rate taxpayers. However, some basic rate taxpayers can be affected, especially if they have a large turnover of gross rental income with a corresponding high amount of mortgage interest that would have been offset under the old rules. In extreme cases, tax liabilities can increase by around £20,000 by the time the new rules are fully implemented.

Property and trading income allowance

From 6 April 2017, the first £1,000 of gross trading or property income will be exempt from income tax and individuals with income below the allowance will no longer have to report or pay tax on that income. If income exceeds £1,000, the taxpayer will have the following choice:

  • deduct the £1,000 allowance from their gross income and will be subject to tax on the excess, or
  • deduct all allowable expenditure in the usual manner

This simplification measure will be beneficial for those who have low levels of property income. Landlords who have income in excess of the new allowance should consider carefully which of the above options will be most efficient for them. The best approach may change from tax year to tax year.

Making Tax Digital (MTD)

All unincorporated businesses and landlords with gross income or annual turnover below £10,000 will be exempt from the new quarterly reporting obligations. However, everyone else will have no choice but to comply with the new MTD regime from April 2018, or, as recently confirmed, April 2019 if turnover is below the VAT threshold.

Landlords who use a letting agency will be least affected, as the information required for quarterly submissions should already be available, albeit it is important for every landlord to have a good understanding of the information that is required and the deadlines involved so as to ensure that their agency provides them with everything they need in order to meet their reporting requirements in good time.

Landlords with more than one property may have to change their method of accounting as they will be required to submit income and expenditure for each individual property they own, rather than submitting total figures as is currently required on annual tax returns.

The above is a taster of the changes that landlords will need to consider over the coming months.