Is your salary around £30,000- £40,000 a year? Do you own a buy to let property? Are you paying a mortgage for the property? If so, you could face a dramatic increase in your tax bill!
The new changes in interest relief for landlords is a huge topic for discussion. It will affect all buy to let landlords in some form and the implications are wide ranging. As there is so much to say on the topic, we thought it would be useful to discuss a common example of the type of tax payer in the most vulnerable situation due to the new changes.
Until April 2017, 100% of mortgage interest on buy to let properties was an allowable deductible expense. This meant that if a landlord had £10,000 of property income, £8,000 of mortgage interest and £2,000 of allowable other expenses, such as repairs, the landlord would not have made any profit from the let property, and therefore had no tax to pay.
From the tax year beginning 6 April 2017, this has changed. Now, relief for mortgage interest and interest on other loans related to the property business are restricted. This restriction will gradually increase year on year until 2021, when none of interest will be an allowable, deductible expense. Instead the taxpayer will be given a tax deduction of 20% of the interest they have paid. It is important for landlords to be aware of these changes, as it can have a massive effect on their tax bill, some landlords even paying tax when they have made losses.
What you need to know
- Finance cost relief restriction applies to all residential property businesses subject to income tax
- Gradually being phased in from 5 April 2017 until 2021 where it will be fully in place
- 2017/18 75% finance costs allowable and 25% gets 20% tax reduction
- 2018/19 50% finance costs allowable and 50% gets 20% tax reduction
- 2019/20 25% finance costs allowable and 75% gets 20% tax reduction
- 2020/21 No finance costs allowable and 100% gets 20% tax reduction
- Applies to overseas residential property, but does not apply to furnished holiday lettings and limited companies whose business is letting residential properties.
How will it affect me?
Let’s assume you fit the profile of the common example described earlier – you earn a salary of around £40,000 a year, you have one property that you let out which you are currently paying a mortgage on, but after all the expenses you pay related to the property, you aren’t making any profit.
Now let’s pretend that your property income and expenses are as follows:
10,000 rental income
8,000 mortgage interest
2,000 other allowable expenses
Following this example, in the 2016/17 tax year you would have no tax to pay as your income less expenses equates to nil. Your tax bill will continue to be nil, with these new rules until the allowable element of your mortgage interest drops to a level that means your taxable “rental profit” (not actual profit as you are still paying for your mortgage interest!) takes your taxable income into higher rates.
Using the exact same figures each year, this would mean that you would be paying £1,600 in tax by the tax year 2020/21 even though you have made no profit!
Implications and considerations
The impact of these changes could be huge for some landlords. Many people who have never had any tax to pay could end up with huge tax bills, which they cannot afford to pay. There are other consequences to be aware of for landlords, due to the new rules. Student loan repayments may be affected, as well as tax credits. Capital gains tax rates may be higher and child benefit clawback charges could be incurred.
There has been a lot of debate and speculation around what landlords in this situation should do. However, it is difficult to generalise advice, as the most tax efficient option is dependent on each individual landlord’s circumstance.
Examples of the different options are: Selling the rental property, increasing tenant’s rents, incorporating, timing expenditure, or just carrying on as usual. As mentioned before, there is not a one size fits all answer and choosing any one of these options can have a knock-on effect, and depending on your other income, could increase your tax bill in other ways.
Why have the rules changed?
According to HMRC, the reason for these changes is “To make the tax system fairer, the government will restrict the amount of Income Tax relief landlords can get on residential property finance costs (such as mortgage interest) to the basic rate of tax. This will ensure that landlords with higher incomes no longer receive the most generous tax treatment. To give landlords time to adjust the government will introduce this change gradually from April 2017 over 4 years.” – www.gov.uk
Although this is HMRC’s reasoning, the impact the changes will have on many landlords who will now have a huge tax bill could also have a knock on effect for tenants. With more and more landlords selling their properties to avoid an unaffordable tax bill, and others increasing rent so they can afford the tax, it results in fewer rental properties at higher prices, making it increasingly difficult for tenants to find an affordable home.
Overall, it is difficult to see how the effect of these changes to will be “fairer” for landlords, especially those who will now be paying tax on losses. It is important for landlords to think about what they should to do to if they face a big increase in their tax.
Let us help you
As you can see, this is a very complex topic with many different factors to take into consideration. The implications vary from person to person, depending on their individual circumstances and other sources of income. If you are a landlord and worried about how these changes may affect you, please get in touch. Rosslyn Associates are Chartered Tax Advisers with over 30 years of experience. We can discuss your current situation and explore all the different options, to ensure you make the most tax efficient decision for you. We will make sure you have peace of mind with the knowledge that you won’t pay more tax than you have to.