As an individual landlord you can‘t deduct finance costs, including interest, from your residential property rents for tax purposes. Instead, you get tax relief for those costs as a basic rate tax credit calculated at 20% of the lower of:
- finance costs for the year plus any unused finance charges brought forward;
- your property income profits with no deduction for finance costs or your adjusted total income for the year that exceeds your Personal Allowance.
In years where the property income is low, or a loss, little tax credit can be set-off, so the excess interest which is not relieved is carried forward to the next tax year.
In 2021/22 Bob the Builder had trading profits of £13,500. It was his first year in which he let out a property and he received rents of £3,000, paid mortgage interest of £4,000 and incurred £6,500 of allowable expenses.
Bob made a loss of £3,500 (£3,000 – £6,500) on his property which can‘t be set against his trading profits. As Bob has zero property profits for the year, he can‘t set off a tax credit derived from his finance costs against his 2021/22 tax liability.
However, both his property loss of £3,500 and the unused finance costs (£4,000) are carried forward to the next tax year.
In 2022/23 Bob has a better year. He received rental income of £18,000, paid property expenses of £1,500 and £6,000 as interest. The loss from 2021/22 of £3,500 is set against his rental income. His trading profits have also improved to £26,000.
The amount of tax credit is calculated as 20% of the lower of:
- finance costs= £10,000 (£4,000 + £6,000)
- net property profits = £13,000 (£18,000 – £1,500 – £3,500)
- adjusted total income = £26,430 (£26,000 + £13,000 – £12,570)
Bob‘s tax credit for 2022/23 is calculated as £10,000 x 20% = £2,000.
He has used all his property loss and obtained tax relief for the unused interest paid in 2021/22.
There is no limit on how many years the unrelieved finance costs can be carried forward.