Phasing in the new tax system for landlords

It is becoming apparent that there are still some residential landlords and brokers who are not aware of the full impact of the forthcoming changes to how income tax will be calculated. In particular, basic rate tax payers could find themselves being tipped over into the next bracket, as Gavin Elley explains.

We at MFB have been talking for some time about the new tax system for landlords which is being phased in over four years to 2020.

Now it seems that some lenders too are doing their bit to make the broker community aware of the changes that are happening which will have a fundamental impact on how landlords are taxed. Several lenders have published useful tables, graphs and worked examples to push the message.

What is becoming apparent is that there are a number of landlords and brokers who are still not aware of the full impact of the changes so here are some numbers to illustrate the point.

In 2016 landlords could offset 100% of the mortgage interest against the rental income that they received.

2016

Rental income

£20,000

Mortgage interest

£8,000

Allowable costs

£4,000

Taxable income

£8,000 (£20,000 minus £8,000 minus £4,000)

Tax due

£1,600 (20% taxpayer), £3,200 (40% taxpayer)

BTL Profit – 20% taxpayer

£6,400

BTL Profit – 40% taxpayer

£4,800

From 2020 landlords will only get mortgage interest relief on 20% of the mortgage interest AND mortgage interest will not be deductible before calculating taxable profit.

If you are a lower rate taxpayer you MAY not be affected - but in reality if you own two or more properties, then the rental income from these (before deducting financing costs) could easily push a landlord into the higher rate bracket.

Consider a person currently earning just £28,000 per annum (UK median salary) – as they grew their portfolio it would currently take only £17,000 of taxable rental income to go into the higher rate tax bracket. That could equate to say two properties at just over £700 per month net income (rental minus allowable costs).

This situation was explained in some detail by our Finance Director when the tax changes were first announced.

2020

Rental income

£20,000

Allowable costs

£4,000

Mortgage Interest

£8,000 (cannot be deducted)

Taxable income

£16,000 (£20,000 minus £4,000)

Tax before interest relief

£3,200 (20% taxpayer), £6,400 (40% taxpayer)

Mortgage Interest Relief (20% of £8,000)

£1,600

Tax due

£1,600 (20% taxpayer), £4,800 (40% taxpayer)

BTL Profit  - 20% taxpayer

£6,400 (£16,000 minus £8,000 minus £1,600)

BTL Profit  - 40% taxpayer

£3,200 (£16,000 minus £8,000 minus £4,800)

You will notice that for lower rate taxpayers there is no change but it significantly reduces the profit for a higher rate taxpayer. For landlords that are highly geared the effects could be more profound.

To soften the blow, the Government is phasing in the changes starting in the next tax year 2017/18, when 75% of the mortgage interest will be deductible from rental income. From 2018/19 that will fall to 50%, then 25% in 2019/20 until 2020/21, when no mortgage interest will be deductible from rental income.

To show you what this means for the coming tax year (2017/8), here is a worked example for a higher rate taxpayer (as it will have no effect on a lower rate taxpayer). 

2017/18

Rental income

£20,000

Allowable costs

£4,000

Mortgage interest

£8,000

Deductible mortgage interest (75% of interest)

£6,000

Taxable income

£10,000 (£20,000 minus £4,000 minus £6,000)

Tax before interest relief

£4,000

Mortgage Interest relief (20% of £2,000)

£400

Tax due

£3,600

BTL Profit - 40% taxpayer

£4,400 (£10,000 minus £2,000 minus £3,600)

These changes will affect your investment strategy going forward, not just for future purchases but also for any properties you already own, so it is vital that you take professional advice from a qualified accountant or tax adviser.

A solution for some landlords has been to incorporate, i.e. hold properties in a limited company structure. We are seeing a surge in landlords making new purchases this way but landlords also have to consider how to treat properties they already own personally.

Should they retain personal ownership and take the tax hit? Sell up and get out? Or set up a limited company of their own and sell their properties into it (which is a sale at open market value and all the costs that are associated with it!!). There is no easy answer, so if you haven’t already, please, take professional advice.

As always, if you need help with the finance side of things, please get in touch by email or you can call me on my direct line: 01625 416398.

 

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