If you own a furnished holiday letting, there are a number of advantages available to you in terms of tax which are not available to standard residential lettings.
One of the key advantages is in reference to the treatment of interest and finance costs, let me explain more…
Relief restriction for owners of standard residential lettings
Did you know that residential landlords can now only obtain relief for interest and finance costs, such as mortgage interest, as a basic rate tax reduction, regardless of the rate at which the residential landlord pays tax?
The interest and finance costs incurred are not deducted when working out the taxable profit, so the tax is initially worked out on the profit without taking account of the interest and finance costs.
The tax liability is then reduced by 20% of the interest and finance costs, capped at the lower of 20% of the taxable profit or the amount that reduces the tax liability to nil.
Any unrelieved interest and finance costs can be carried forward for relief as an income tax deduction in calculating the tax liability of the same property business in a later tax year, with the costs being relieved at the first available opportunity.
This approach has a number of downsides – relief is only given at 20% even if the landlord is a higher or additional rate taxpayer and relief may not be given in full in the tax year in which the costs are incurred.
Deduction in full for furnished holidays letting owners
The changes to interest rate relief do not apply to furnished holiday lettings, and where a let qualifies as furnished holiday let, interest and finance costs can be deducted in full when working out the taxable profit.
Unlike standard residential lettings, the deduction is not capped, and can give rise to a loss which may be carried forward and set against future profits from the same furnished holiday business.
Also, as relief is by deduction, relief is given at the landlord’s marginal rate of tax not at 20% where the landlord is a higher or additional rate taxpayer.
Here’s an example to illustrate this:
Helen is a residential landlord.
For 2021/22 her taxable profit before taking account of interest costs on the associated mortgage is £30,000.
Mortgage interest paid in the year is £8,000.
Helen has other income from her photography business and pays tax at the higher rate of 40%.
Before applying the basic rate tax reduction, the tax on the property income is £12,000 (£30,000 @ 40%). The basic rate tax reduction in respect of the mortgage interest reduces this by £1,600 (£8,000 @ 20%) to £10,400.
Mark has a furnished holiday let on which profit before deduction of interest costs is also £30,000.
He too pays mortgage interest of £8,000 and, like Helen, has other income and is a higher rate taxpayer.
However, unlike Helen, he can deduct the full amount of the mortgage interest, reducing the taxable profit to £22,000, on which tax of £8,800 (£22,000 @ 40%) is payable.
Despite identical profit and interest, Mark pays £1,600 less in tax than Helen as he is able to obtain relief for his interest costs at his marginal rate of 40%.
If you own a furnished holiday let and would like to find out more, get in touch. We can talk through this advantage and look at what other advantages may be applicable to you.