Firstly, a summary of the key tax changes for landlords;
- Tax year 2017/18 – 75% of mortgage interest will be fully allowable and the remaining 25% available at the basic rate;
- Tax year 2018/19 – 50% of mortgage interest will be fully allowable and the remaining 50% available at the basic rate;
- Tax year 2019/20 – 25% of mortgage interest will be fully allowable and the remaining 75% available at the basic rate; and
- Tax year 2020/21 – mortgage interest deduction will only be given at the basic rate
The mortgage interest relief restriction does not apply to properties qualifying as ‘furnished holiday lets’ and commercial properties. Whilst the government’s intention behind the measure is to restrict mortgage interest relief to 20%, the actual mechanism of how the restriction works has a wider impact on individual landlords. 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. As the interest cost is completely disallowed, it means the individual will have higher overall taxable income. This could push an individual into a higher rate of income tax (40% / 45%), 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.
Example; John is employed and earns £80,000 in salary and bonuses per annum. As well as his employment income, John owns a buy-to-let residential property from which he receives £40,000 a year. John has a mortgage on the property and pays £25,000 interest per annum so that his net rental profit before tax is £15,000. John’s income tax position and net profit after tax over the next five years is shown in the table below;
|Net rental income||15,000||21,250||27,500||33,750||40,000|
|Less: personal allowance||(11,000)||(10,375)||(7,250)||(4,125)||(1,000)|
|Income tax payable||27,200||29,950||33,700||37,450||41,200|
|20% tax credit for interest cost||-||1,250||2,500||3,750||5,000|
|Total income tax payable||27,200||28,700||31,200||33,700||36,200|
|Net profit after tax||9,000||7,500||5,000||2,500||-|
Higher rate and additional rate taxpayers investing in residential property will need to consider the appropriate property ownership structure in light of the changes. A corporate structure may be more attractive going forwards, as the same restriction for mortgage interest will not apply to companies. In addition, the main rate of corporation tax will reduce to 17% from April 2020, further increasing the difference between corporate and personal tax rates. Whether a company is suitable will depend on the amount of SDLT the company will have to pay to acquire the properties, whether any capital gains tax is payable when the property is transferred to the company and whether borrowing has to be renegotiated.