Buy-to-let landlords urged to pay close attention to tax rule changes

Buy-to-let landlords urged to pay close attention to tax rule changes

The government's attack on landlords is unlikely to end anytime soon despite widespread criticisms, after it released details of how the new mortgage interest relief restrictions will be phased from next April.

The government has come under attack for its plans to slash the tax relief that landlords can claim on buy-to-let income, and there were faint hopes among some landlords that the new Chancellor Philip Hammond may take a closer look at mortgage interest tax with a view to potentially restructuring it. But that will now almost certainly not happen after a fresh post on the government website by the Treasury confirmed that the tax relief that landlords of residential properties get for finance costs will be restricted to the basic rate of Income Tax from April 2017.

Earlier this year, David Cox, managing director of The Association of Residential Letting Agents, was among those well positioned to predict that a change in government policy would not happen.

Following discussions with the Treasury, he said: "I can honestly say that I would be very surprised if the government was to perform a U-turn. It has already allocated the money it will raise from investors to the tune of around £880m a year from 2020.

"There may be a few minor amendments, but ultimately landlords are being made to pay more to cover the increase in the housing budget."

Landlords are now being urged to pay close attention to the new tax rules coming into play for residential property from April 2017

Nimesh Shah, partner at Blick Rothenberg, said: "Investors in residential property need to be aware of this marked new change and need to start planning for their portfolios now.

"Whilst the additional 3% SDLT has created the most anxiety amongst buy-to-let investors, the restriction to interest relief may have been overlooked, but this is likely to have greater longer-term effect on after tax returns."

Yesterday, HMRC finally issued their guidance on these changes, which include some worked examples to illustrate how landlords will be affected.

Shah said: "HMRC say in their latest guidance that 'all residential landlords with finance costs will be affected, but only some will pay more tax.'  The statement is quite misleading as the changes could have quite far reaching effect, which most buy-to-let landlords will not appreciate.

"A number of individuals have picked up a buy-to-let property in recent years, whether that is an investment property to supplement earnings, a second home which is occasionally rented out or a property which they have inherited and decided to let out.

"It is wrong for HMRC to say 'only some will pay more tax',  as entitlement to child benefit, personal allowance and the pension annual allowance will all be affected indirectly through how this new measure operates in practice. It would also not be an unreasonable assumption to say that the majority of buy-to-let landlords will be higher or additional rate taxpayers and they will be affected without question. This change will capture a large proportion of the  buy-to-let landlord population."

When the announcement was made at the Summer Budget, the measure was described as restricting interest relief at the 20% basic rate. However, the actual mechanism of how the restriction works has wider impact.

Shah explained: "Currently, buy-to-let landlords can deduct all their interest cost to calculate rental profits.  When the new measure takes full effect, the interest cost will be completely disallowed in computing rental profits and instead a tax credit equal to 20% of the interest will be given against the person's income tax liability.

"Whilst this may sound like what the Government intended the measure to achieve, the fact the interest is completely disallowed means the individual will have higher overall taxable income."

He added: "This could push an individual into a higher rate of income tax (40%/45%), start to reduce their personal allowance (if their income now starts to exceed £100,000), affect their entitlement to child benefit and restrict the amount on which they can claim tax relief for pensions."

The following two examples highlight some of the issues:

 Example 1

Susan is retired and owns a number of residential buy-to-let properties.  Her only source of income is the rents from her residential property portfolio which total £60,000 per annum.  She has mortgages on the properties and she pays annual interest of £25,000.  Therefore, her net profit before tax is £35,000.

Susan's income tax position and net profit after tax over the next five years is as follows:

Tax year16/17 17/18 18/19 19/20 20/21
Rental income60,00060,00060,00060,00060,000
Loan interest(25,000) (18,750) (12,500) (6,250)-
Net rental income35,00041,25047,50053,75060,000
Less: personal allowance(11,000)(11,000)(11,000)(11,000)(11,000)
Taxable income24,00030,25036,50042,75049,000
Income tax payable4,8006,0508,20010,70013,200
20% tax credit for interest cost-1,2502,5003,7505,000
Total income tax payable4,8004,8005,7006,9508,200

Net profit after tax30,20030,20029,30028,050

Example 2

Peter is employed and earns £80,000 in salary and bonuses per annum.  As well as his employment income, Peter owns a buy-to-let residential property from which he receives £40,000 a year.  Peter has a mortgage on the property and pays £25,000 interest per annum, so that his net rental profit before tax is £15,000.

Peter's income tax position and net profit after tax over the next 5 years is as follows: 

Tax year  16/17 17/18 18/19 19/20 20/21
Employment income80,00080,00080,00080,00080,000
Rental income40,00040,00040,00040,00040,000
Loan interest(25,000) (18,750) (12,500) (6,250)-
Total income95,000101,250107,500113,750120,000
Less: personal allowance(11,000)(10,375)(7,250)(4,125)(1,000)
Taxable income84,00090,875100,250109,625119,000
Income tax payable27,20029,95033,70037,45041,200
20% tax credit for interest cost-(1,250)(2,500)(3,750)(5,000)
Total income tax payable27,20028,70031,20033,70036,200
Net rental profit after tax9,0007,5005,0002,500-

The above illustrations are but two examples of how the measures have wider effect than simply restricting the tax relief on the mortgage interest cost.  Buy-to-let investors should urgently review their portfolios and mortgages and calculate the exact impact on their after tax returns. 

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