Furnished Holiday Lettings - an alternative proposal

One of the common concerns clients come to us with is the removal of mortgage interest relief introduced in April 2017 under Section 24 for unincorporated landlord portfolios.?Although this section was introduced over 4 years ago, the loss still bites very hard.

So as part of your 3 to 5 year plan, regarding the direction of your future portfolio maybe it is worth considering an alternative in the form of holiday lets.

For tax purposes, furnished holiday lettings are something of a special case and benefit from a number of advantages not available to standard residential lets. One of these advantages is in relation to the treatment of interest and finance costs.

Residential landlord – Restriction of relief

Residential landlords can 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 are not deducted when working out the taxable profit, and the tax is initially worked out on the profit without taking account of the interest and finance costs. The resulting 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.

Furnished holidays lettings – Deduction in full

This does 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. 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.

Example

Toby is a residential landlord. For 2021/22 his taxable profit before taking account of interest costs on the associated mortgage is ￡30,000. Mortgage interest paid in the year is ￡8,000.

Toby has other income from his 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.

Tom 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 Toby, has other income and is a higher rate taxpayer.

However, unlike Toby, 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, Tom pays ￡1,600 less in tax than Toby as he is able to obtain relief for his interest costs at his marginal rate of 40%.

It is simply not possible to change your entire portfolio immediately but with conscious planning it is possible to migrate some of the portfolio or rethink the future properties you are buying.

With additional advice regarding Family Investment Companies (FICs) and holding companies, any transfer of properties between companies within the group will benefit from SDLT relief.??With our specialism in both the legal and taxable elements of your portfolio we are well placed to provide a holistic view to ensure you move forward enhancing your profit margins not reducing them.