As we reach the end of 2016, many landlords are breathing a sigh of relief! But what does 2017 have in store for the BTL industry, and are you prepared? Tax changes: In a nutshell, the changes mean that the amount of income tax relief landlords can get on residential property finance costs will be restricted to the basic rate of tax. The changes are likely to flip how many landlords in the UK receive relief for interest and other finance costs. Although the changes are to be gradually introduced over the course of four years, April 2017 sees the first round of amendments, which are likely to take many by surprise.
Currently, landlords can claim tax relief on their mortgage interest payments. In other words, they can offset the cost of the mortgage interest from the rental income when they calculate their profits. So, if a landlord collects rental income of £10,000 a year, but pays mortgage interest of £9,000, ‘the profit’ is the difference between the two, or £1,000. And landlords pay tax on their profits according to their income tax band.
In this simplified example, a basic-rate taxpayer would pay 20% tax on £1,000, or £200, and keep £800. The tax bill for a 40% taxpayer would be £400, leaving £600, or £450 for a taxpayer at the 45% additional rate, leaving £550. However, the rules, which are coming into play in April, will change the way that profit is calculated for landlords. Finance costs will no longer be taken into account to work out taxable property profits. Instead, mortgage interest tax relief will gradually be cut back to 20% between 2017 and 2020.
So, a landlord with rental income of £10,000 and who pays mortgage interest of £9,000 will in future have to pay tax on the full amount of £10,000, now considered to be ‘the profit’, less a 20% credit on the mortgage interest of £9,000. It is really an amendment – for landlords – of the generally accepted accounting principles used for businesses. The government is no longer considering ‘borrowing or finance's as an ‘expense’ and this has an effect on how it determines ‘profit’.
The tax bill for a higher rate taxpayer would therefore work out at £4,000 (40% of £10,000 profit) minus £1,800 (20% of £9,000 interest), which equals £2,200, up from £400 under the current tax regime. That’s a large increase of £1,800. A landlord who pays 45% tax could expect a tax bill of £2,700, compared with £450.
If you are a higher-rate taxpayer, the new tax will wipe out your returns if your mortgage interest is 75% or more of your rental income. The threshold for additional-rate taxpayers is when mortgage interest reaches 68% of rental income. The tax liability of a basic-rate taxpayer is unchanged. However, the new profit calculation could push a basic-rate taxpayer into a higher tax band.
Passing these extra costs onto tenants in rents is currently a contentious issue but there is evidence to suggest this is what many landlords will do. For example two thirds of 2,883 landlords surveyed by the Residential Landlord’s Association said they would increase their rents to offset the tax changes.
According to the government only one in five landlords are expected to pay more tax when new section 24 rules, under the Finance Act 2015, are implemented, but a number of industry experts dispute this.
You will be affected if:
Nothing much will change for you if you are:
Although it all sounds very confusing, don’t panic too much – the changes are being phased in gradually, and won’t be fully in place until April 2020. Come April 2017, you will still be able to deduct some of your finance costs when working out your taxable property profits during the transitional period. These deductions will be gradually withdrawn. They will be replaced with a basic rate tax relief reduction. The percentage of finance costs deductible from rental income will firstly be reduced by 25%, then 50%, then 75%, then 100% at the end of the rollout.
% of finance costs deductible from rental income
% of basic rate tax reduction
|2017 to 2018||75%||25%|
|2018 to 2019||50%||50%|
|2019 yo 2020||25%||75%|
|2020 to 2021||0%||100%|