LOSS OF TAX RELIEF FOR LANDLORDS
Tax has been one of the major worries for landlords over the past year. Many changes have been introduced but what do these changes mean? How will affect you?
It is fair to say that it has not been a good time for a lot of landlords over the last couple of years, as the Government as hit hard with many movements of tax measures.
If you’re new to buy-to-let, you might not appreciate the effect of this change.
Up to now, buy to let clients have been able to claim tax relief on their mortgage interest payments at their marginal rate of tax. This means you can deduct your mortgage interest (plus associated costs like arrangement fees) along with all your other costs before determining your taxable profit.
For Example
|
£10,000 |
Rental Income | |
|
(£5,000) |
Mortgage interest Costs | |
|
(£1,000) |
Other Costs | |
|
£4,000 |
Profit |
You are then taxed on that profit at your marginal rate —
basic rate (currently 20%) taxpayer would pay tax of £800
higher rate (currently 40%) taxpayer would pay £1,600
From the 2017-18 tax year onwards this will gradually change, which is likely to increase the amount of Income Tax due. For many landlords, this change could make their business unprofitable.
The change will be phased in over four years, starting in the 2017-18 tax year, when 25% of finance costs will be subject to the new rules, growing to 50% in the 2018-19 tax year, 75% in 2019-20 and from the 2020 tax year onwards these rules will apply to all finance costs.
By the time the new measures have fully taken effect in April 2020, you will no longer be able to deduct mortgage interest costs from your taxable profits.
Instead, everyone will be able to claim a basic rate allowance for their finance costs — irrespective of their marginal rate.
So let’s take the same figures as above and see how things have changed:
|
£10,000 |
Rental Income | |
|
|
||
|
(£1,000) |
Other Costs | |
|
£9,000 |
Profit |
Wow! A basic rate taxpayer would pay £1,800 tax on that new £9,000 profit, and a higher rate taxpayer would pay £3,600.
Finally, everyone gets to claim a basic rate deduction of 20% of that £5,000 mortgage interest. That’s £1,000 can be deducted.
So the final tax payable is..
Basic Rate Payer:
20% tax on £9,000 profit = £1,800
Minus £1,000 deduction (20% of £5,000 interest cost)
= £800 to pay
Higher Rate Taxpayer
40% tax on £9,000 profit = £3,600
Minus £1,000 deduction (20% of £5,000 interest cost)
= £2,600 tax to pay
You will notice that the basic rate taxpayer ends up paying the same amount of tax under the new system: £800. The higher rate taxpayer, however, ends up paying £1,000 more.
That does not mean that the basic rate taxpayer is not affected because the deduction is applied after calculating the taxable profit.
Once your income is calculated, this includes employment, property and other sources, the basic rate payer who is currently under the higher rate threshold may end up being pulled to a higher rate. It is good to keep in mind that by 2020 the higher rate threshold will have risen from the current £42,385 to £50,000.
An additional change is that the government changes will abolish the 10% Wear and Tear Allowance. For more information see our previous blog post on this issue.
Increasing your rents to compensate will not help, as most tenants are already paying as much as they can afford. Although all changes to lower you tax come with risks, here are a few things you can try:
ü Get lower rates of interest by switching to a shorter-term fixed rate, although these mortgages carry more risk.
ü Paying Corporation tax (which is lower) by placing your property portfolio in a limited company structure, although fewer providers is a concern as they are not keen to lend to companies.
ü Transferring ownership to a spouse if they pay a lower rate of tax. You need to be careful this does not lift them into a higher tax band.
If you do feel you may be affected and you would like to discuss any aspects of the landlord tax changes, please contact jmd@proactive-accounting.com for more information.