Lisa Simon, Partner and Head of Residential Division, offers a practical view on residential letting issues currently in the news.

Mortgage interest taxation changes and finance options for landlords

Since 6 April 2017, mortgage interest relief has been restricted to basic rate (20%) income tax, with the change being phased in over four tax years.  This has a number of implications and options for landlords.  In this article, Nimesh Shah, Partner from Blick Rothenberg Chartered Accountants, and Mike Perrin, Head of Sales from Private Finance, consider the options available.

Expand the articles below to find out what they have to say.

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;


100%
75%
50%
25%

Tax year 2016/17
2017/18
2018/19
2019/20
2020/21










Employment income 80,000
80,000
80,000
80,000
80,000










Rental income 40,000
40,000
40,000
40,000
40,000
Loan interest (25,000)
(18,750)
(12,500)
(6,250)
-
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)










Taxable income 84,000
90,875
100,250
109,625
119,000










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.

Nimesh Shah            
Partner
+44 (0)20 7544 8746

nimesh.shah@blickrothenberg.com
Blick Rothenberg
16 Great Queen Street
Covent Garden
London WC2B 5AH
www.blickrothenberg.com

Whilst there is a compelling rationale for having your investment property under a limited company structure a review of the whole of the mortgage market suggests there are a number of other factors to consider.

Many clients look to utilise the profits held within trading limited companies to purchase investment property.  There are only a handful of lenders that will consider this.  Clients tend to assume that a company with a track record will find it easier to get finance, in fact, the reverse is true.  Should a trading company have a claim against it they may seek redress against the property assets, potentially forcing sale of the property and compromising the security of the lender.  Lenders prefer to lend to an SPV or Special Purchase Vehicle which have only one SIC code determining the company permitted activities.  

First consideration is that whilst there are 60 lenders active in the buy to let market, only 17 of these will facilitate lending under a limited company structure.  Whilst this is less than 30% of the market 17 still sounds like a sufficient number of lenders.  Despite the growth in demand for limited company borrowing, lenders see limited companies as a barrier between themselves and the borrower.  Subsequently, the lenders offering limited company solutions are predominantly specialist lenders, the mainstream players are simply not in this space.  

This situation is magnified when one considers the impact of PRA regulations for portfolio landlords.  The PRA began regulating buy to lets in January 2017.  The first impact of this was an increase in rental stress testing which reduced borrowing for a given rental by 22%.  The second key change was in October 2017 when additional requirements were put in place for portfolio landlords, determined as those with four or more mortgaged properties.  These clients are required to provide additional information and the whole of their portfolio is stressed, not just the subject property.  One lender currently increased the cost of their five year fixed rate by 50% when borrowers have 10 or more mortgaged properties.  There are different solutions available for those with only one or two properties as some lenders will take into account earned income to enhance lending amounts.

Specialist lenders have specialist rates.  Here’s an extract from recent research provided to a client considering putting his new purchases in 2019 under a limited company;

Description: Fived year fixed personal names Five year fixed limited company
Initial rate: 1.99% 3.59%
Bank fees: £1,995 £995

 

In this scenario there was an 80% increase in interest costs by placing the lending under an SPV limited company, however, this isn’t always the case.  Should the client be a portfolio landlord or there be another restriction forcing the use of a specialist lender there may be no impact on interest rates as they may be paying higher rates already.  The other factors that can determine the requirement for a specialist lender can include the property type (HMO, multi-unit property or lending over adverse commercial), scenario (immediate re-mortgage, overseas resident or low rental yield).

The cheapest form of buy to let lending is generally from mainstream lenders ‘dabbling’ in buy to let, terms become more specialist, therefore higher as more mitigating factors are added.  Key is determining the best terms for you and your property.  Even for the same applicant the best lender for property ‘A’ may be different from that for property ‘B’.

In summary, when considering the most suitable solution for you it is vital that you consider both the financial and tax implications of your proposal.  Carter Jonas recommends that you seek professional advice.

Mike Perrin
Head of Sales
+44 (0)20 7317 2820

mike.perrin@privatefinance.co.uk
Private Finance Ltd.
29 Lincolns Inn Fields
Holborn
London WC2A3EG
www.privatefinance.co.uk

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Partner - Head of Residential Division
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Lisa Simon heads up our Residential Division, which includes sales, new homes, lettings and property management across our National network. She joined Carter Jonas in 2011. Her twenty years plus experience has been largely in London and the Home Counties working with Landlords and Tenants. Lisa oversees the day to day running of our residential branches and acts as a key contact for some of our portfolio clients. She also runs our corporate services department liaising and promoting our properties to companies and their relocation agents. Lisa resides in West London with her husband and two daughters.

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