Buy-to-let landlords - tax relief for loan interest
Alan Boby, Partner at UK200Group member firm Ellacotts LLP looks at the implications for buy-to-let landlords following the changes to tax relief on mortgage interest announced in the post-election Budget.
The post–election Budget has seen a number of surprises and some that are crucial to landlords. Buy-to-let mortgage interest relief is fully tax-deductible against rental income until April 2017, but will then be restricted.
Under the new rules the rate at which interest relief is given will gradually fall to the basic rate of 20% by the tax year 2020/2021. Landlords liable to income tax at the higher (40%) and the additional rate (45%), will no longer benefit from full tax relief on mortgage interest.
Restricting interest relief will increase “top line” income, which may result in individuals becoming higher rate taxpayers. If earnings are in excess of £100,000 the personal allowance will also be lost. This will affect the high income child benefit charge, as landlords may lose child benefit, despite receiving what could be a modest amount of rental income.
Non–UK resident buy-to-let landlords may also be affected depending on the amount of their UK income source.
Currently an additional rate (45%) taxpaying landlord, receiving gross rents of £100,000 and paying, say, £30,000 in mortgage interest, will be able to deduct the interest in full from rental profits. Therefore, the landlord receives tax relief of £13,500 (45% of the mortgage interest). The landlord’s net rental income after interest is £70,000. The total tax liability will be 45% of £70,000 (ie £31,500), so the net income after tax and interest is £38,500.
When the new rules are fully phased in (from the tax year 2020/21), tax relief for mortgage interest paid in the example above will be restricted to the basic rate of income tax (currently 20%). The landlord would still pay 45% income tax on rental income net of interest (ie £31,500) but will only be entitled to tax relief at 20% in respect of mortgage interest (tax relief of £6,000). This leaves a tax liability of 25% on the remaining £30,000 of rental profits and additional income tax of £7,500 will be due. Total income tax will therefore be £39,000 so net income after tax and interest is £31,000 (£7,500 less than before).
The draft legislation does not affect rental income received by companies, which could be a more tax-efficient approach for higher and additional rate taxpayers. Creating a limited company to purchase investment property may have its benefits although transferring property already owned to a company could be expensive and not worthwhile.
The impact of the new rules will depend on how much the individual landlord pays in interest, the rates at which they are paying income tax and on whether the property is held in their own name or via a company.
As with all such tax situations, advice should also be sought before proceeding. For further details call Alan Boby on 01295 250401 or email firstname.lastname@example.org
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