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Have you ever wondered how landlords save tax on interest payments when renting both residential and commercial properties? The truth might surprise you!
If you’re a landlord renting out different types of properties, understanding how you can get relief on your loan interest can mean big savings at tax time. But here’s the catch—different rules apply depending on whether your properties are residential, commercial, or a mix of both.
How Does Interest Relief Work?
For landlords who haven’t set up a limited company (unincorporated landlords), the way interest payments are handled depends on the property type:
- Commercial properties: Good news! You can deduct ALL your loan interest when calculating taxable profits.
- Residential properties: This is a bit trickier. You can’t deduct the interest directly from profits anymore. Instead, you get relief as a tax reduction at the basic rate (20%).
- Furnished holiday lets: Until 5 April 2025; landlords can still deduct the full interest from profits. But after that date, this benefit disappears, and you’ll only receive a 20% tax reduction—just like other residential properties.
Why Is This Important?
If you have several properties or a building with both a shop and an apartment, understanding how to use these rules can help you save on taxes. Let’s look at some clear examples.
Example 1: Mixed Portfolios
Imagine John rents out three houses and one office building:
- Residential mortgages: £60,000, £100,000, £120,000 (Total interest: £16,800)
- Commercial mortgage: £90,000 (Total interest: £6,300)
John can fully deduct £6,300 in interest from his commercial mortgage when calculating his taxable profits. For his residential mortgages, he can only claim a tax reduction, which is limited to £3,360. This amount is 20% of £16,800.
The Step You Might Be Missing: Apportionment
What if one loan covers both residential and commercial properties? You need to divide your interest payments between these two types of properties. The rules say you should split the costs in a way that is “just and reasonable.” You can use one of these methods to divide them:
- Floor area
- Original purchase price
- Market value
- Rental income
Here’s a key tip: calculate the numbers for each method to find out which one saves you the most on taxes!
Example 2: Mixed-Use Properties
Brandon owns a property that has a shop on the ground floor and a two-floor flat above it. He borrowed £180,000, and this year’s interest totals £11,250.
Using the floor area to split costs, Brandon decides:
- Residential (flat) gets two-thirds: £7,500 interest
- Commercial (shop) gets one-third: £3,750 interest
Brandon deducts the £3,750 commercial interest directly from his profits. The remaining £7,500 for the residential flat can only reduce his tax bill by £1,500 (20% of £7,500).
What if You’re a Company?
Corporate landlords have it easier! They can deduct all interest costs, no matter what type of property they rent. There’s no need to apportion costs, simplifying the process significantly.
The Power Move for Landlords
Grasping the concept of the “just and reasonable” method and selecting the appropriate option for your situation can greatly enhance your savings potential. This is important whether you’re making your initial investment or looking to grow your existing portfolio. A solid understanding of interest relief rules can provide you with a distinct financial benefit and better position you for success.
Ready to optimise your property profits and cut your tax bill? Now’s the time to review your interest relief strategy!