Changes to tax relief for residential landlords

s24 Finance Act 2015Between April 2017 and April 2020 the government is set to phase out higher tax relief on mortgage interest payments for buy-to-let landlords. This means that over the next four years the amount of mortgage interest tax relief that buy-to-let landlords can claim will fall to just 20%.At present landlords can off-set the cost of mortgage interest payments against rental income and pay tax on the profit at their marginal rate of income tax.For example: (if you pay 40% income tax)Rental income:                    £20,000Less Mortgage interest:     £13,000Profit :                                    £7,000Tax on profit at 40% :                               £2,800Tax is payable on the profit meaning HMRC receives £2,800 and the landlord receives £4,200. From 2020, tax is payable on the full rental income of £20,000 less a tax credit equivalent to basic-rate tax on the mortgage interest paid.So as a higher rate tax payer the landlord pays 40% on £20,000 (£8,000) less the 20% credit on the mortgage interest (20% of £13,000 = £2,600). Rental Income:                                      £20,000Tax on rental income (@ 40%)                                        £8,000Less tax credit on £13,000 @ 20%                                  £2,600Tax on profit:                                                                       £5,400 Therefore HMRC receives £5,400 and the landlord receives £1,600. The tax bill has risen by 93%!It should be noted that the full effect of this change is to be phased in over four years such that 75% of finance costs will be allowable in 2017/18, 50% in 2018/19, 25% in 2019/20 and fully in place for 2020/21. The remaining finance costs for each year will be given as a basic rate tax reduction but can’t create a tax refund.If mortgage rates rise then buy-to-let landlords could see profits reduced further. The higher the mortgage as a proportion of the rental income received the less likely landlords are to make a profit and the more likely they are to make a loss.Estimates suggest that by 2020 if the mortgage costs on a buy-to-let property are above 75% of the rental income, higher tax rate landlords will see any profits wiped out. However, it should be remembered that even if there is a negative income yield there is still potential for capital growth.So what can be done to limit the exposure to the new tax changes? The most important action is to take professional advice from your accountant and/or financial adviser.Solutions may include:

  • Incorporation of your buy-to-let into a company structure
  • Switch mortgage debt away from investment properties and on to owner-occupied homes so that there is no buy-to-let mortgage

but personal circumstances will vary and the approaches adopted will have to be tailored to individual needs.An interesting article on this topic can be found at: more information visit the HMRC website using the link: