Landlords understand the changes to buy-to-let tax relief
Blog
April 22, 2016
From the Land and Buildings Transaction Tax to the ‘wear and tear’ allowance and beyond, this year has seen some big changes in the world of buy-to-let. Potentially the biggest change, and the one that could hit landlords hardest in the pocket, is to the way tax is calculated for anyone buying a second home or a buy-to-let property.
How will the changes affect me?
Under the previous rules, landlords were entitled to claim all of the mortgage interest that they paid against the income of their buy-to-let property, and then only pay tax on the remainder, whether that was the basic rate of 20 per cent or the higher rates of 40 per cent and 45 per cent. Other valid expenses could also be deducted before the tax was payable.
However, under the new rules – which will be introduced over a four-year period from April 2017 – this will be restricted to 20% regardless of what rate of tax landlords are paying. This means that higher rate tax payers of 40% or 45% stand to lose at least half of their tax relief.
To give some examples – the following examples are based on somebody who owns a property worth, £250,000 receiving a rent of £17,000 before letting and other costs of £2,000 and who has a mortgage of £180,000 with an interest cost of £9,000. Thus profit before rental interest is £15,000 and after interest it is £6,000.
Example 1
Mr Jones earns a salary (or if self-employed has a taxable profit) of £25,000. His “before” and “after” situation is as follows.
| % Tax | Current Rules | Budget Proposals | |||
|---|---|---|---|---|---|
| £ | Tax | £ | Tax | ||
| Salary | £25,000 | £25,000 | |||
| Taxable rental profit | £6,000 | £15,000 | |||
| Taxable income / profit | £31,000 | £40,000 | |||
| Tax band | Tax band | ||||
| Tax at | 0% | £12,000 | £0 | £12,000 | £0 |
| 20% | £19,000 | £3,800 | £28,000 | £5,600 | |
| Less tax relief on interest | 20% | £9,000 | -£1,800 | ||
| Total tax | £3,800 | £3,800 | |||
In other words, he suffers no change in the overall tax liability as a basic rate taxpayer. If Mr Jones is an employee who had PAYE on his salary, he will have already paid £2,600 of PAYE leaving him £1,200 of tax to pay on his rental income – i.e. 20% of his taxable rental profit of £6,000.
Example 2
Miss Docherty earns a salary of £75,000. Her position is altered as follows:
| % Tax | Current Rules | Budget Proposals | |||
|---|---|---|---|---|---|
| £ | Tax | £ | Tax | ||
| Salary | £75,000 | £75,000 | |||
| Taxable rental profit | £6,000 | £15,000 | |||
| Taxable income / profit | £81,000 | £90,000 | |||
| Tax band | Tax band | ||||
| Tax at | 0% | £12,000 | £0 | £12,000 | £0 |
| 20% | £38,000 | £7,600 | £38,000 | £7,600 | |
| 40% | £31,000 | £12,400 | £40,000 | £16,000 | |
| Less tax relief on interest | 20% | £9,000 | -£1,800 | ||
| Total tax | £20,000 | £21,800 | |||
In this case, Miss Docherty’s total tax bill has gone up by £1,800 due to the restriction on interest relief to 20% on £9,000 of interest expense – so £9,000 x (40% – 20%). She will have already paid £17,600 of PAYE and so the tax on her net rental income of £6,000 has effectively risen from £2,400 (£20,000 – £17,600) to £4,200 (£21,800 – £17,600) – an effective tax rate of 70% on her net profit.
Example 3
Mrs Smith might hope that she is not affected by the change since her salary is £43,000 – which together with her rental profit of £6,000 leaves her below the higher rate threshold of £50,000. But, as the following example shows, she does get caught by the restriction.
| % Tax | Current Rules | Budget Proposals | |||
|---|---|---|---|---|---|
| £ | Tax | £ | Tax | ||
| Salary | £43,000 | £43,000 | |||
| Taxable rental profit | £6,000 | £15,000 | |||
| Taxable income / profit | £49,000 | £58,000 | |||
| Tax band | Tax band | ||||
| Tax at | 0% | £12,000 | £0 | £12,000 | £0 |
| 20% | £37,000 | £7,400 | £38,000 | £7,600 | |
| 40% | £0 | £0 | £8,000 | £3,200 | |
| Less tax relief on interest | 20% | £9,000 | -£1,800 | ||
| Total tax | £7,400 | £9,000 | |||
Mrs Smith will suffer an additional £1,600 of tax as her gross income including her rental profit before tax deduction will be £58,000 – so her additional tax is £8,000 x (40% – 20%).
But it’s not all doom and gloom. The first thing to note is that, as in the worked examples above, landlords who are basic rate tax payers won’t be affected at all. Similarly, these changes will be phased in gradually, with no change in the current tax year (15/16), and the increase stepping up in four equal increments over the next four years. That’s ample time to check if the changes will affect you and, if they do, to take steps to limit the potential damage.
Dougie says…
“That’s where we come in. With three generations of experience, we know the market inside and out. Whether your portfolio is one property or one hundred, we can offer free expert advice, keep you up to date with changes in law and legislation, and help make sure your properties provide the best return on investment possible. Give me a call or pop in to the office for a chat and see how we can help make the most of your portfolio.”
Dougie Harvey
Mail: dougie@harveylets.com
Call: 0141 204 1100
