Buy-to-let tax relief changes – how they will affect landlords
Friday 05 February 2016
The summer budget of 2015 may go down as one of the most disastrous ever for private landlords as Chancellor George Osborne unveiled plans to curb the amount of mortgage interest relief they could claim against their taxable income starting in 2017.
Under the current system the cost of finance such as mortgage interest is allowed as a deduction from rent, but from April 2017 onwards the amount which can be deducted is to be reduced by 25 per cent a year until 2020 when no relief will be given as a deduction from rent.
Some landlords will pay higher-rate tax
The new rules will see tax calculated on rental profits after costs such as property maintenance have been deducted but interest and other finance charges will be excluded from such tax savings.
Once tax has been calculated landlords will be able to offset 20 per cent of finance charges against the tax due.
An unfortunate side-effect of the plans is that mortgage interest payments which are currently seen as tax-deductible will be seen as rental profits – which means landlords who are currently categorised as basic-rate taxpayers could be pushed up into the higher-rate tax bracket.
Simple Landlords Insurance has teamed up with Tax Advantage, who specialise in landlord tax affairs, to produce a projection which shows how a basic-rate taxpaying landlord could become a higher-rate taxpayer between 2017-2020.
In this scenario Andy has an annual salary of £35,000. He collects £12,000 in rent annually from a property with costs of £2,000 and mortgage interest of £5,000.
Total taxable income is £40,000, which is below the higher rate tax threshold.
Based on the current system Andy would pay £1,000 in tax on his property income annually but the table below shows how this will change.
During the first year of the phased change 25 per cent of Andy’s mortgage interest payments are taxed at the basic rate of tax and leave him paying no more than at present but in year two because he pays 50 per cent of his mortgage interest charges at his basic rate he winds up paying higher-rate tax on £35.
This continues until 2020/21 when 100 per cent of the mortgage interest is relieved at 20 per cent which increases Andy’s tax from £1,000 in 2017/18 to £1,507 in 2020/21.
Andy’s example shows how paying tax on a greater percentage of his mortgage interest coupled with other income pushes him into the higher-rate tax band.
Other possible impacts:
- Increase in taxable profit will lead to restrictions on child and working tax credits and capital gains could be taxed at 28 per cent instead of 18 per cent
- If you are already a higher rate taxpayer claiming child benefit, the changes could take your income over the £50,000 threshold and result in some or all of the child benefit having to be repaid
Some landlords may consider setting up companies
If you are not fortunate enough to have a long-lost rich uncle remember you in his will then paying down the debt on your buy-to-let mortgage to reduce your interest payments is not an option, so you might consider moving the property into a limited company.
This, in effect, is like selling your property to a company which you own but you would have to pay stamp duty land tax on the transaction, which now stands at 3 per cent.
Capital gains charged on the transfer to the company may be deferred until it is sold again and profits are taxed at 20 per cent, though this is set to reduce to 18 per cent by 2020.
This deferment of capital gains tax is called incorporation relief, but in order to qualify you have to demonstrate that the property is part of an actual business rather than just a passive investment.
One way of doing this could be to provide additional services such as cleaning or gardening.
If the property is mortgaged you need to consider how the company will raise finance to take over the borrowing on the property.
And if the company sells the property it will pay corporation tax on the gain and shareholders will suffer capital gains tax on the sale of their shares to get the cash out of the business, which effectively means a double tax charge.
You can take up to £5,000 per year as a tax-free dividend but any income you take over this amount will be charged at 7.5 per cent as a basic-rate taxpayer, 32.5 per cent as a higher-rate payer and 38.1 per cent as an additional-rate payer.
Most financial experts advise that the statutory obligations and costs involved in running a company outweigh any tax savings for most landlords unless they have a sizeable property portfolio.
Dave Murphy, of Tax Advantage, said: “There’s little doubt that landlords will be taking a long, hard look at their accounts right now, but for most they are best carrying on as normal.
“For some who are higher rate taxpayers they will feel a bit of pain on the loss of higher rate relief on mortgage interest, but property still remains a strong alternative to other investments.”
For more information on how your buy-to-let business will fare under the Finance Act 2015 phone Tax Advantage on 0333 012 4079 or email firstname.lastname@example.org.
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