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Are you confused by the upcoming changes in tax changes for buy to let income?
The change to mortgage interest relief was first announced in the 2015 emergency Budget.
Since then it’s become variously known as Section 24, The Alice In Wonderland Tax and The Tenant Tax – whatever you call it, a whole lot of people still don’t quite understand how it works and what it means.
So, let’s work this through…
The old rules – until April 2017
Up until April 2017, you can deduct 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 tax of £800, and a higher rate (currently 40%) taxpayer would pay £1,600.
(There’s also an “additional rate” of 45% for incomes about £150,000, which we’re ignoring here just for simplicity.)
The new rules
The new measures are being phased in, and will have fully taken effect in April 2020, at which point you will no longer be able to deduct mortgage interest costs from your taxable profits if the property is owned by an individual. (If the property is owned as a company, you continue under the old rules and none of this applies.)
Instead, everyone will be able to claim a basic rate allowance for their finance costs — irrespective of their marginal rate.
So let’s take the same figures as above and see how things have changed:
£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.
Click here to for the mortgage works Buy to Let Tax Change Calculator
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?
Two things.
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 actually 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 we do about it?
The first thing to do is work out what effect it will have on your portfolio – you can use the calculator above. The greater your income and the more highly leveraged you are, the greater the effect – and for some people, it will be bad. But you might be surprised by how little difference it makes in your situation.
If the situation is grim, you’ve got various options:
- Set up a company and sell your properties to it – although this will trigger CGT and Stamp Duty liabilities, and you’ll need to remortgage
- Sell properties that are no longer profitable
- Attempt to cut costs to offset the extra tax you’ll be paying
And if you don’t own investment properties yet?
If you don’t own properties yet but you’re thinking about it, you might want to consider buying them in a limited company structure to swerve this whole business altogether.
Source: PropertyGeek
Buy to Let Tax Change Calculator courtesy of the mortgage works
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