The next instalment of tax changes to buy-to-let investments came in last month. If you are a buy-to-let landlord, or you are thinking of this type of investment, you need to understand the implications.
Reform of tax relief on buy-to-let residential mortgage interest was a surprise in the 2015 summer Budget. The change is being phased in over four years starting from the 2017/18 tax year. Landlords of furnished lets are also being hit by the abolition of the wear-and-tear allowance that took effect from April 2016.
Borrowers will get a 20% tax credit on interest under the new scheme, instead of deducting the interest against rental income. This is equivalent to basic rate relief, and it increases borrowing costs for higher or additional rate taxpayers.
The move to the new system will be phased in with part of the interest remaining deductible and part eligible for the tax credit. The amount of interest deductible against rental income is 75% for 2017/18, reducing by 25% each year after. Borrowers can claim 25% of the tax credit in 2017/18, increasing by 25% a year to reach 100% from 2020/21.
One consequence is that taxable income will increase because the costs which can be offset against taxable rental income are being phased out. This can have unfortunate side effects.
For example, more taxable income could push a borrower over an important tax threshold, such as the £100,000 income level at which the personal allowance – the amount of income you don’t pay tax on – begins to be tapered away.
The first stage of the interest tax relief changes may not have become apparent to some landlords until 31 January 2018, when their final balancing payment of tax for 2017/18 became due.
In the longer term, the impact could be significant for higher and additional rate taxpayers, particularly if the gap between rental income net of expenses and mortgage interest is small.
The switch to a 20% tax credit could even turn a profit into a loss for a higher rate taxpayer, as the simplified example shows.
|Costs||2016/17 (£)||2020/21 (£)|
|Tax due @ 40%||400||3,800|
|Tax credit on interest at 20%||N/A||(1,700)|
|Income net of tax and interest||£600 profit||£1,100 loss|
What’s more, two other factors have emerged to complicate the tax affairs of private landlords.
- interest rates have started to rise, making the loss of full tax relief that much costlier.
- Secondly, in last November’s Budget the Chancellor revised the rules for corporate capital gains, increasing the tax payable on future gains.
Buy-to-let owners who hold their properties in companies – an increasingly common approach prompted by the reform of interest relief – are affected by the freezing of indexation relief from January 2018. Some buy-to-let investors are planning to sell in the face of the growing tax burden.
For any advice in this area, please do get in touch.