Understanding Tax Relief for Interest and Finance Costs: Residential vs. Commercial Property

Sarah Bradford explains how tax relief is given in respect of interest and finance costs relating to mixed-use property lets and mixed portfolios. 

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All is not equal when it comes to tax relief for interest and finance costs, with the relief route depending on whether the property is a residential or commercial property, and also on whether the landlord is running an unincorporated property business or a property company. 

What type of property? 

For residential properties (including from 6 April 2025, those let as furnished holiday accommodation) let by an unincorporated property business, relief for interest and finance costs is given as a basic-rate tax reduction. What this means is that 20% of the interest and finance costs are deducted from the tax due on the profits of the property rental business, capped at the lower of: 

• 20% of the interest and finance costs; 

• 20% of the property business profits; or 

• 20% of the landlord’s adjusted net income. 

Where it is not possible to relieve the costs in full (as would be the case if the property business made a loss), the unrelieved costs are carried forward for relief in future years. 

For 2024/25 and earlier tax years, unincorporated landlords letting accommodation that met the definition of a furnished holiday letting were able to deduct the interest and finance costs in full in calculating the rental profits on the holiday lets. From 6 April 2025 onwards, holiday lettings are treated in the same way as other residential lettings, with relief for associated interest and finance costs being given as a basic-rate tax reduction. 

Where the landlord is a property company, interest and finance costs for residential lettings can be deducted as for other allowable expenses when calculating the taxable profits. The restriction does not apply. 

For commercial lettings, the rules are the same regardless of whether the property is let by an unincorporated landlord or by a company. In each case, the costs are simply deducted in full in calculating the taxable profit of the property business. 

As different rules apply to different types of lets where the landlord is an unincorporated property business, the treatment of interest and finance costs can become complicated where the landlord lets mixed-use properties or has a mixed property portfolio. 

Mixed-use properties 

An unincorporated landlord may let a property that comprises both residential and commercial space, such as a shop or restaurant with a flat above it. To the extent that it relates to the commercial part, the interest and finance costs can be deducted in calculating the taxable profit of the property rental business. However, in so far as the interest payments relate to the residential part, relief is given as a basic-rate tax deduction.  

Where the borrowings relate to the property as a whole, the interest and finance costs should be apportioned on a ‘just and reasonable basis’, and relief for each portion should be given under the relevant rules. HMRC does not prescribe how the apportionment should be done – it just needs to be just and reasonable. Possible options include an apportionment on the basis of floor area, rental income (where the parts are let separately), or by reference to the value of the different parts. 

Example 1: A ‘just and reasonable’ apportionment 

James purchased a three-storey property comprising a ground floor shop with a two-storey flat above. He purchased the property with a mortgage of £200,000, on which interest is payable at the rate of 6% – an annual cost of £12,000.  

His annual rental income is £36,000. He incurs other allowable expenses of £4,700 in the year. 

In working out his taxable profit, he must split the interest and finance cost between the shop and the flat. This is done on the basis of floor area, with one-third of the costs (£4,000) attributable to the shop and the remaining two-thirds (£8,000) attributable to the flat. 

He is able to deduct the £4,000 attributable to the shop, along with the other allowable expenses of £4,700 from the rental income, to arrive at a rental profit of £27,300. James has other income and is a higher-rate taxpayer. Consequently, at 40%, the tax on his rental profit is £10,920. He is able to obtain relief for the remaining £8,000 of interest as a basic-rate tax deduction, reducing the tax payable on his rental income by £1,600 (£8,000 @ 20%) to £9,320. 

As James can use any just and reasonable basis of apportionment, it is advisable to select the one which gives the best result (i.e., one in which more of the interest costs are allocated to the shop). 

Mixed portfolios 

A landlord running an unincorporated property business may have a mixed portfolio comprising residential and commercial properties. It may also include some mixed-use properties. 

Where the borrowings relate to a specific property, relief for the interest and finance costs is given according to the rules that apply to that type of property (i.e., as a basic rate deduction for residential properties, or by deduction in calculating taxable profits for commercial properties). With the exception of any mixed-used properties (in respect of which the rules described above apply), apportionment is not necessary – each loan is considered separately. 

Example 2: No apportionment needed 

Julia runs an unincorporated property business comprising three residential properties and a workshop. The borrowings on each property are as follows: 

Julia can deduct the interest and finance costs of £3,800 relating to the loan on the workshop in calculating her taxable rental profits. However, relief for the interest and finance costs which relate to the residential lets, which amount to £23,500, is given as a basic-rate tax deduction, and Julia can deduct £4,700 (£23,500 @ 20%) from the tax due on her rental profit (subject to the application of the cap, if applicable). 

As the loans relate to distinct properties, no apportionment is needed. 

By contrast, where the borrowings relate to more than one property or to the business as a whole, the interest must be apportioned on a just and reasonable basis, with relief given for each portion according to the rules for the type of let to which it relates. 

Example 3: Apportionment based on cost  

Jane has been running an unincorporated property business for many years and has a mixed portfolio comprising both residential and commercial properties. Currently, there are seven residential properties and three commercial properties in the portfolio. 

Jane has a single borrowing facility for the business as a whole. For the tax year in question, interest of £30,000 is payable on the business borrowings. As the borrowings do not relate to a specific property or properties, the interest costs must be apportioned on a just and reasonable basis so that relief can be given in the correct way.  

The residential properties cost £1.5m in total when purchased, whereas the commercial properties cost £1m. The interest costs for the year are apportioned by reference to the original cost of the properties, with 60% being allocated to the residential properties (£18,000) and 40% (£12,000) being allocated to the commercial properties. In calculating the rental profits for her property business, Jane can deduct the interest costs of £12,000 allocated to the commercial properties. Relief for the remaining £18,000 allocated to the residential properties is given as a tax reduction of £3,600 (£18,000 @ 20%). 

Alternatively, the costs could have been apportioned by reference to the rental income from the different properties. 

Practical tip 

Where interest and finance costs incurred by an unincorporated business have to be apportioned between residential lets and commercial lets, or in a mixed-use property, between the residential element and the commercial element, choose a basis of apportionment that gives the best outcome. Any basis should be fine as long as the apportionment is just and reasonable.