You’re making substantial repairs and improvements to your buy-to-let property. You’ve borrowed from the bank to finance the repairs and these loans will wipe out the profit for a few years. What tax relief are you entitled to and how can you claim it?
Repairs and improvements
The basic rules for calculating the taxable profit on a property rental business are straightforward and logical; it’s simply income less expenses. However, things get trickier where the expense relates to repairs, improvements and finance costs. A tax deduction from profit is allowed for the first category but not the others.
Trap. Where repairs are substantial HMRC may argue that they are in effect improvements. Generally, a like-for-like repair or replacement using similar materials (or more modern equivalents) is deductible from income. This applies to structural work and to equipment that’s fixed to the property such as boilers and water systems.
Finance costs
Tax relief for finance costsis also problematic. When calculating profit or loss on the letting of residential property you’re not allowed a tax deduction for finance costs, e.g. loan interest. Instead, you’re entitled to a limited tax credit (sometimes referred to as a tax reducer). The rules for working out the credit aren’t simple.
Example. In 2023/24 Janelle’s rental income net of tax-deductible expenses was £8,000. Janelle paid financial costs (mortgage interest) of £5,800. She is a higher rate taxpayer and the tax on the rental income is therefore £3,200 (£8,000 x 40%) ignoring the tax credit for the finance costs. The tax credit allowed is the lesser of 20% of:
- the finance costs, in this case £5,800
- the rental profit, in this example £8,000
- Janelle’s adjusted total income.
Tip. If your tax-deductible expenses exceed your rental income for the year, i.e. you make a loss, you aren’t entitled to a credit for any finance costs but the good news is that both the loss and the excess tax credit can be carried forward and used to reduce tax on the rental income for later years. The excess tax credit is the difference between 20% of the total finance costs and the amount calculated and the amount allowed for the year.
What finance costs are affected?
A finance cost for the purpose of the restriction doesn’t just mean interest on loans, it includes costs incurred in connection with loans etc. such as arrangement fees and other types of financing, such as overdraft and interest charges etc.
Excess expenses and finance costs
Having worked out your net rental income and the tax credit, the figures will need to be included on your self-assessment tax return on the “UK Property” or the “Foreign” pages, whichever is applicable. Both include spaces specifically to record losses where expenses exceed rental income and excess finance costs.
Tip. It’s important to enter the amount of any losses and unused tax credits in the correct place on your tax return. Failing to do so risks losing the right to claim them after four tax years have elapsed.
Where your tax-deductible expenses exceed your rental income, the excess (the loss) is carried forward and used to reduce future profits. No deduction from profit is allowed for interest and finance costs; instead any tax payable of the rental income profit is reduced by a maximum of 20% of the finance cost. Losses and unused finance cost credits must be claimed on your self-assessment tax return or you risk losing them.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.