Interest Rate Relief – Changes you should know about

on February 16, 2017

Landlords saw a second huge tax assault on buy to let by the Chancellor, which will force investors to pay thousands more in stamp duty on new properties. This is on top of the loss of tax reliefs unveiled in July 2016. Leaving all the big property developers aside. There are a huge number of Self-employed landlords who make a living or secure a  pension contribution out of a buy to let property.

The new 3% additional stamp duty rate on any property bought as a buy to let or as a second home, will see the tax on a £175,000 purchase jump six-folds from £1,000 to £6,250. For someone buying in London, say a two-bed flat for £400,000, the stamp duty rises from £10,000 to £22,000.

Not only will prospective landlords have to pay far more than conventional residential buyers, they also face much heavier taxes on their profits. The maximum tax relief will drop from 45% and 40% to just 20% so that an investor with a £150,000 buy-to-let mortgage on a property worth £200,000 is likely to see his or her net annual profit collapse from £2,160 a year to just £960.

WHAT IS MORTGAGE INTEREST RELIEF FOR BUY-TO-LET INVESTORS?

The tax has always been charged on income received from rental properties. This is calculated after allowable expenses are deducted. Major areas landlords are eligible for tax relief to include:

Rental insurance

Any maintenance of the property

Letting agency fees

10% of annual NET rental income to cover depreciation of furnishings

And crucially:

Interest on a buy-to-let mortgage

This meant that if you have an interest-only mortgage, your whole monthly repayment will be tax deductible.

This allowed buy-to-let landlords to offset their mortgage interest payments against their income, whereas homeowners who live in their properties cannot.

The current rules on Interest Relief

Until April 2017, you can deduct 100% of your mortgage interest (plus associated costs like arrangement fees) along with all your other costs before determining your taxable profit.

So to take a simple 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 — so a basic rate (currently 20%) taxpayer would pay a tax of £800, and a higher rate (currently 40%) taxpayer would pay £1,600 and additional rates for income above £ 150,000.

The new rules on Interest Relief

The good news is that this is introduced in stages so there is no major panic right now.  However, 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.

The Staging of this will mean landlords will be able to obtain relief as follows:

  • in 2017 to 2018 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
  • in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
  • in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
  • from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction

So let’s take the same figures as above and see how things have changed:

Tax Year2016/172017/182018/192019/202020/21
Rental Income10,000.0010,000.0010,000.0010,000.0010,000.00
Mortgage interest %100%75%50%25%
Mortgage Interest5,000.003,750.002,500.001,250.00
Other Costs1,000.001,000.001,000.001,000.001,000.00
Profits4,000.005,250.006,500.007,750.009,000.00
Basic rate Tax payer – 20%800.001,050.001,300.001,550.001,800.00
New Relief250.00500.00750.001,000.00
Tax to Pay800.00800.00800.00800.00800.00
Higher Rate tax payer – 40%1,600.002,100.002,600.003,100.003,600.00
New Relief250.00500.00750.001,000.00
Tax to Pay1,600.001,850.002,100.002,350.002,600.00

 

  • assuming your rental income, tax rates remain the same

 

£10,000 rental income

[£5,000 mortgage interest costs – NOT DEDUCTED]

£1,000 other costs

= £9,000 profit

 

A basic rate taxpayer would pay £1,800 tax on that new £9,000 profit, and a higher rate taxpayer would pay £3,600.

BUT WAIT…everyone gets to claim a basic rate deduction of 20% of that £5,000 mortgage interest cost. That’s £1,000.

So the final position is…

Basic rate taxpayer:

20% tax on £9,000 profit = £1,800

Minus £1,000 deduction (20% of £5,000 interest cost)

= £800 tax 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

So what’s happened?

Firstly, you’ll notice that the basic rate taxpayer ends up paying exactly the same amount of tax under the new system: £800. The higher rate taxpayer, however, ends up paying £1,000 more.

But this doesn’t mean that the basic rate taxpayer is unaffected. Because the deduction is applied after calculating the taxable profit, everyone’s “profit” has increased — from £4,000 to £9,000.

This means that people whose income (from property plus employment and any other sources) is currently below the higher rate threshold may end up getting pulled into the higher rate band as a result of their higher property “profits”.

(The silver lining, such that it is, is that the higher rate threshold will have risen from its current £42,385 to £50,000 by the time this measure takes full effect in 2020.)

What do we do what do we do? Firstly, DON’T PANIC. See if you have any other alternative ways of structuring your ownerships. In some cases forming a limited liability company might be a good option to consider. Where using the income for pension contribution you can claim other relief available for the pension.  Furnished Lettings allow a 10% wear and tear. The list goes on. . Speak to your accountant. If you don’t have one then its time to call us.

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