Mortgage income relief changing from 6th April 2017
by Charleston Financial
Higher earning landlords are no longer be able to receive the most generous tax treatment, thanks to a levelling of the mortgage interest relief playing field.
In an effort to inject more fairness into the tax system, the former chancellor, George Osborne, two years ago announced he was making the changes and set them to come into force this year.
It was widely believed that Osborne's move was to kerb the practice of Buy-to-Let because its growing popularity was causing aspiring first-time buyers to have to compete with landlords for the limited number of properties that were on the market.
Osborne's adjustment will now restrict the proportion of income tax relief landlords are able to receive on the finance costs of residential property - such as mortgage interest.
It's a phased programme and, to soften the blow for landlords, the changes are being introduced gradually over the next four years. They begin from the beginning of the new tax year, 6 April 2017.
Personal Buy-to-Lets now less profitable
The effect that all Buy-to-Let landlords will increasingly feel is a squeeze on profits.
Up until now, landlords have been able to deduct the mortgage interest they pay along with other allowable costs, from any rental income they have received before they have had to sit down and calculate their tax liability.
The Government's aim is to adjust the finance cost relief for individual landlords in four years time by restricting it to income tax's basic rate, which is currently 20%. Tax relief will be given, not as a reduction to taxable rental income, but as a tax liability reduction instead.
Table 1 here is a snapshot of how the changes will be phased in:
|Tax relief on Finance Cost||2016/17||2017/18||2018/19||2019/20||2020/21|
And table 2 shows how the changes could affect the profits of a landlord with a higher income who is taking a notional rental income of just £10,000:
|Existing System (2016/17)||New System (2020/21)|
|Mortgage interest and other allowable costs can be deducted before calculating taxable profit||Mortgage interest cannot be deducted before calculating taxable profit|
|Rental income||£10,000.00||Rental Income||£10,000.00|
|Taxable Income||£3,000.00||Taxable Income||£8,000.00|
|Tax @ 40%||£3,200.00|
|Mortgage Interest Relief (20%)||£1,000.00|
|Tax Due||£1,200.00||Tax Due||£2,200.00|
Broken down year by year, table 3 gives an idea of the impact the new system is likely to have as it is phased in:
|Current 40% taxpayer||Old System||New System||Buy to Let Bill||Net Profit|
Mortgage interest no longer tax deductible for higher rate tax payers
The changes will not only affect those of you who let the residential properties you own as an individual, it will also affect you if you do so in a partnership or as a trust.
Your finance costs will no longer be taken into consideration when the taxable property profits are calculated.
Instead, what will happen is that when the Income tax on your property profits and any other income sources - like other fees you are paid and your pension - has been assessed, a basic rate tax reduction will be applied to your Income tax liability. For the majority of landlords, this will be the basic rate value of their finance costs.
If you are one of the people who fall into any of the following categories you will be affected:
- individual UK residents who let residential properties overseas or in the UK itself
- those individuals who do not reside in the UK but who let residential properties in the UK
- individuals who are in partnerships that let UK and overseas properties
- individuals who are beneficiaries of trusts or trustees and are liable to pay UK Income tax on any profits made from letting properties
In other words, any residential landlord who has finance costs is affected by the changes. But not all will necessarily pay more tax.
Limited company Buy-to-Lets now the favoured ownership route
As the new system is an adjustment of income tax liabilities it will not affect you if you rent a property through a company. Indeed, those who won't suffer from the finance cost restrictions are:
- companies that rent properties in the UK and are resident here
- companies that are not resident in the UK but rent out properties here
- landlords of premises defined as Furnished Holiday Lettings
Those of you who fall into these categories will continue to receive relief for interest and other finance costs as usual.
This is why, from the middle of last year, rising numbers of Britain's landlords have been selling their own properties to their own limited companies to use the loophole that allows them to avoid paying more tax under the new system.
As a result, landlords can claim the costs they incur running their Buy-to-Lets properties as "allowable expenses", which effectively allows them to write off the cost of their mortgage payments, any wear and tear and maintenance, as well as letting agents' fees etc.
Although holding Buy-to-Let property in a limited company means the landlord has to pay corporation tax on taxable profits at a rate of 20%, this is due to fall to 18% by 2020.
It does need to be borne in mind that although there are tax advantages to switching ownership of a property into a company, the move is not without cost.
If the value of the Buy-to-Let property has risen since it was originally bought, selling it to a limited company will trigger a capital gain.
The capital gains tax that will fall due will depend on the income tax rate paid by the landlord. Capital gains tax is levied at a reducing rate from 28% for a higher rate taxpayer to just 18% for someone who only pays the basic rate.
There is also the stamp duty to think about. This is also payable on the re-purchase of the property by the limited company, and all Buy-to-Let sales are subject to a 3% surcharge on the rate of stamp duty that is owed.
Changing a property's ownership to a company from an individual also usually means the mortgage contract has to be adjusted. This, in turn, is likely to trigger an early repayment charge to redeem an existing mortgage if its term is yet not up. It may also lead to a remortgage fee for a new product, as well as additional legal fees and a valuation fee.
Under the finance cost restriction, what is included?
Finance costs that will be restricted include the interest on:
- loans - including those loans taken out to buy furnishings
- bank overdrafts
Additional costs that are affected are:
- alternative finance returns
- fees and other incidental costs for repaying or getting mortgages and loans
- discounts, disguised interest and premiums
When those people who take out a loan for both commercial and residential properties come to working out the finance costs for their residential properties, they need to reasonably apportion the interest.
Only the finance costs that apply to the residential properties are restricted under the new system. This also applies if the loan is partly for a self-employed business and partly for the residential property.