As of 1st April 2017, hundreds of thousands of landlords who currently pay the basic rate of tax will find themselves forced into the higher tax bracket as a result of new restrictions on landlord tax relief. Yet despite this, very few landlords know anything about the changes or how it will affect them.
Currently, mortgage interest payments are one of a number of expenses that landlords can deduct as a business cost. However, once changes are fully phased in by 2021, landlords will no longer be able to deduct mortgage interest payments or any other finance-related costs from their turnover before declaring their taxable income.
How are the changes going to be introduced?
The changes will be phased in over the next four tax years, starting from April 2017, as follows:
2017/18 tax year – Landlords can claim 75% of allowable expenses, and will receive relief at the basic rate (20%) on the remaining 25%;
2018/19 tax year – Landlords can claim 50% of allowable expenses and will receive relief at the basic rate (20%) on the remaining 50%
2019/20 tax year – Landlords can claim 25% of allowable expenses and will receive relief at the basic rate (20%) on the remaining 75%
2020/21 tax year – the switch will be complete, with the only tax relief being the basic rate of 20% on your allowable expenses.
The announcement to cut mortgage interest tax relief in the 2015 Budget came as a surprise to many landlords.
Landlords need to seriously look at how their investments are performing, just as they would if they had stocks and shares. If a stock price is falling, there is a decision to stick it out or sell. In the case of property, of course there is always capital growth, but what about monthly income versus costs?
Landlords will be faced with higher costs. At least at present, interest rates are historically low, but what happens when rates rise?
An example of how a landlord’s tax liability could change over the next 4 years
John is a landlord. He is already a higher rate taxpayer (40%).
John’s Buy-to-let property generates £20,000 per annum.
His allowable expenses (e.g. mortgage interest) total £13,000
Tax year 2016/2017 (Old system) – John pays tax on the profit after all expenses are deducted. £20,000 – £13,000 = £7,000 (John pays 40% tax on £7000 which is £2,800)
Tax year 2020/2021 (New system) – If John’s rental income and expenses remain the same he will pay tax on his total income of £20,000 = at 40% this is £8,000 (less the basic-rate relief of 20% on expenses of £13,000, which is £2600). £8,000-£2600 = £5,400.
What can landlords do?
Landlords should carry out a business review on each of their rental properties. Remember, banks will be more stringent on affordability checks when it comes to buy-to-let mortgages as well, so it’s vital to know how much is coming in and how much will be going out.
Landlords need to list down all their costs (letting agent fees, management fees, maintenance, etc.) and consider areas where savings could be made. It’s extremely important to seek expert advice from an independent financial advisor who can support a robust and comprehensive financial plan for both the short and long-term.