Changes to Landlord Tax Relief: What it could mean for you.

Introduction:

From April 2017, the way that landlords have to declare their rental income has started to change. This means that landlords have seen the amount of tax relief they can claim for their buy-to-let mortgage costs drop by 25% year on year up until April 2021.

The government claimed that 82% of landlords wouldn’t be impacted by the changes. However, research undertaken by AXA insurance suggests that over 40% of landlords believe that the changes will lead to additional tax costs for them.

With the end of this progressive change in sight, we look at what the new scheme will mean for you:

What are the changes to landlord tax relief?

Before 2017, landlords could deduct finance costs such as mortgage interest from their earnings, thus lowering their taxable profit and reducing the amount of tax they’d have to pay.

From April 2017, the government changed income tax relief for residential landlords. Instead of tax relief on costs, there would be a basic tax reduction of 20% on one of the following costs, whichever is the lowest in value:

• Finance costs such as interest on a mortgage, loans or an overdraft
• Net rental income
• Adjusted total income; profit after deducting tax relief and personal allowance.

This change was introduced incrementally from 2017 with a certain percentage of costs subject to the old method of full tax relief and the remainder being subject to the new scheme.

The percentage that could be processed through the original scheme has decreased by 25% each year so that, from April 2020, you are no longer able to deduct any of your mortgage expenses from your income to reduce your tax bill.

Tax Year	Percentage of mortgage interest deductible from rental income.	Percentage of mortgage interest (or other costs) qualifying for 20% tax credit under new scheme
2016/17	100%	0%
2017/18	75%	25%
2018/19	50%	50%
2019/20	25%	75%
2020/21	0%	100%

From April 2020, the full amount of tax relief will be given as a tax credit rather than a reduction in tax liability. This means that landlords will have to declare all of their rental income, pay the full amount of income tax and then claim the 20% relief back.

The government aimed to ensure that these changes would prevent the highest earning landlords from receiving the largest tax relief, whilst having little financial effect on lower earners, those renting through registered companies, or landlords of furnished holiday homes.

What this means for landlords:

The new scheme of tax credits could potentially cause an increase in your tax bill.

Firstly, if you’re a higher or additional rate taxpayer, you won’t get the full amount of tax paid back on your costs. This is because the tax credit is only for 20% of what’s been paid rather than the higher or additional rates of 40% or 45%.

Secondly, lower earners could be pushed up into a higher tax bracket because all income will need to be declared on their tax return rather than costs being deducted first. This could lead to you paying a higher rate of tax overall.

See how these changes could affect the amount of tax you pay:

A landlord has one buy-to-let property and receives £900 a month in rent (£10,800 per year) and pays £650 per month on an interest only buy-to-let mortgage (£7,800 per year). He has a full time job that pays £40,000 per year.

In 2017:

• 100% of the mortgage interest would be deductible from rental income before the landlord was taxed. This would mean a taxable income of £3,000.
• A basic-rate taxpayer would pay £600 in tax at 20%, plus the £7,800 mortgage interest costs. The total payable per year on this property would be £8,400.
• A higher-rate taxpayer would pay £1,200 in tax at 40% plus the £7,800 mortgage interest costs. The total payable per year on this property would be £9,000.

Now:

• Mortgage interest isn’t deductible from income. Tax needs to be paid on the full £10,800 of income from the property.
• A basic-rate taxpayer would pay £2,160 in tax at 20% plus the £7,800 mortgage interest costs. This would mean a total payment of £9,960. They would receive a tax credit of £1,560 for 20% of the mortgage interest costs. Total paid would equal £8,400, the same as 2017. However, the income declared would have risen considerably from £3,000 to £10,800. This has pushed the landlord up into a higher tax bracket as his total declared income is now over £50,000.
• A higher-rate taxpayer would pay £4,320 in tax at 40% plus the £7,800 mortgage interest costs. This would mean a total payment of £12,120. They would receive a tax credit of £1,560 for 20% of the mortgage interest costs. Total paid would equal £10,560; double the tax paid.

What can I do to minimise my costs?

Unfortunately, the new tax credit scheme will leave some people paying more tax on their rental income than before. However, there are ways to make sure you’re not paying too much.

It is important to keep accurate records of the expenses you incur as a landlord as this will impact the amount of tax you pay. Your allowable expenses can be deducted from your income and reduce the amount of money you’ll be taxed on.

Allowable expenses include costs such as maintenance and repair fees, landlord insurance and contents insurance.

The change in tax relief only affects private landlords; so those who own their properties individually or as a couple. If you find you are paying significantly more tax on your rental properties than before, you could consider setting up a limited company which owns the rental properties. This would allow you to continue to deduct your mortgage interest costs before declaring your income.

However, this method will require thorough research as there are several different issues that could leave you worse off than paying the residential landlord tax in the first place. Mortgage rates for businesses tend to be much higher than those for private landlords. You would also need to pay stamp duty when transferring ownership of the property from yourself to the business. If you form a business, you will need to file a tax return for your business and pay corporation tax rather than paying income tax. You will also need to pay yourself dividends to receive an income which will also be taxable.

How Property Tax People can help:

We can help you to get organised and to understand all of the tax legislation surrounding your rental property. We can help you to file your tax returns to make sure that everything is correct and you avoid fines from HMRC for late payments or incorrect calculations.

We can offer advice on the best path for you to take to manage your rental properties; whether you have just one or a whole portfolio.

Contact us today for a consultation on hello@propertytaxpeople.co.uk or 01905 700949.

To read our previous blog posts please click here