If you are a Buy to Let Landlord you will no doubt be aware of how unpopular you are with the Government and the changes that are about to affect you.
The Buy to Let Mortgage tax changes start to kick from 6 April 2017. It means that by 2020 Landlords who own property with a mortgage and are higher rate (40% or 45%) tax payers could face paying up to double the tax they paid before. Although some Basic rate tax (20%) payers will be unaffected, others could find themselves pushed into the higher rate of tax. In a nutshell, whereas mortgage interest was being claimed as a cost against your rental income, the removal of this claim means you could find yourself ‘earning’ more rental income on paper and so falling into a higher tax band.
Until 5 April 2017 the tax you pay on your buy to let property is based on your rental profit made. This rental profit is the difference between rental income less any expenses spent on maintain their properties, as well as mortgage interest paid.
So for example: a landlord has furnished property income of £60,000 a year, but spends £17,000 on maintaining the property, his taxable profit would be:
Rental Income £60,000
Allowable expenses £17,000
Mortgage Interest £12,000
If the landlord has other types of income and is a higher rate tax payer, the tax to pay would be £12,400. However if the landlord has no other income and is a basic rate tax payer, the tax to pay would be £6,200.
Changes to Mortgage Interest Relief
If you are a landlord without a mortgage on your property, then obviously you won’t have been claiming mortgage interest relief, so this won’t affect you.
However, if you do have a mortgage the amount of interest you can claim against your rental income will slowly be reduced over a period of 4 years from April 2017 to 2020. There are two aspects to consider:
The Reduction of Your Claim for Mortgage Interest Against Rental Income:
Over the next four years that amount of mortgage interest that can be claimed will reduce until 2020, at which point you will no longer be able to claim any mortgage interest.
You work out how much you claim over the next four years as a simple percentage of what you are paying as follows;
Tax Year 17/18 – 75%
Tax Year 18/19 – 50%
Tax Year 19/20 – 25%
Tax Year 20/21 and beyond – 0%
The Basic Rate Tax Deduction
In order to offer some relief for mortgage interest HMRC is phasing in something new called Basic Rate Tax Deduction. So after you work out how much tax is payable you can make a reduction to this amount due to HMRC which is calculated as the basic rate of tax, currently 20%, multiplied by the amount of mortgage interest paid.
Again this will be phased in and the amount of this deduction you can claim will be restricted as follows:
Tax Year 17/18 – 25%
Tax Year 18/19 – 50%
Tax Year 19/20 – 75%
Tax Year 20/21 and beyond – 100%
How to the numbers stack up then?
Going back to our earlier example, the landlord has rental profits of £31,000 with income tax of either £12,400 or £6,200 to pay depending on whether they are a higher or basic rate tax payer.
In 2020 the rental profits would worked out as follows:
Rental Income £60,000
Service Charge £17,000
Mortgage Interest £0
Let’s assume for simplicity there are no changes to the tax rates, so even if the Landlord had no other forms of income they would now find themselves a higher rate tax payer since they can’t deduct mortgage interest. So in both scenarios the tax payable would become:
£43,000 x 40% = £17,200
Less basic rate tax deduction (12,000 x 20%) £2,400
Tax due £14,800
That’s an increase of £8,600 for a landlord who was originally a basic rate tax payer, but now finds themselves a higher rate one due to the Buy to Let Tax Changes.
Unfortunately Buy to Let Landlords with mortgages have fallen out of favour with the Government and the new rules stand to have a major impact on property investors and rental yields.
What can you do?
Putting up rents to cover this increased costs, in reality, is not going to be the easy solution to cover this increased tax bill. You could:
1 Move around lenders more and take out short term fixed rate low interest rate mortgage deals. Although this in itself carries cost and risk.
2 Sell a property to reduce overall rental income of your portfolio. Not ideal if you are looking for capital appreciation and plan to hold your investment property for a long length of time.
3 Set up a Limited Company so you pay corporation tax, currently 20% and avoid falling into higher rate of income tax 40%. However, you should seek advice and be careful since moving a property you own into a Limited Company can be considered a sale as well as restrict your borrowing options.
4 Move a property to your spouse if they pay a lower rate of tax. Just be careful they don’t find themselves a higher rate like in our example above.