In this article we outline the changes to landlord interest put in place April 2017.
From 5th April 2017 on-wards, mortgage interest and finance costs will no longer be treated as a fully tax-deductible expense. Instead a “tax relief” capped at 20% will be applied. This will mean higher rate tax payers, and those pushed into higher brackets, will be paying more tax!
Who does this effect?
Individuals renting out residential property with mortgages in their own names. If you own properties in a Limited company, or rent out as Furnished Holiday Lets you will not be affected.
Prior to 5th April 2017, a landlord’s taxable profit would be calculated as the following:
Then the profit would be added to an individual’s other income (for example, employment and pension income) to calculate the overall tax due for the year, based on the tax brackets the income falls into (see the tax brackets table below). Under the new rules, this will no longer be the case.
This new “tax relief” will be deducted from the tax due at a maximum rate of 20% of the mortgage interest. i.e. a deduction at only the basic rate of tax of 20%, even if the individual pays some tax at the higher 40% rate. So, with mortgage interest of £4,000 the tax relief (or basic rate deduction) will be a maximum of 20% of that (£800).
For example, with a salary of 50,000 and, using the same figures as above.
|Old method||New method|
|Tax on property income (40%)||400||2,000|
|Less: 20% “tax relief” on interest (4,000 x 20%) =||0||(800)|
|Total tax due on property income||400||1,200|
As shown above, the landlords tax bill has increased from £400 to £1,200. It is also worth noting that the total income for the year has also increased from 51,000 to 55,000 (profit + other income).
This could have further implications with income dependant benefits such as child benefit.
|Band||Taxable income||Tax rate|
|Personal allowance||Up to £11,000||0%|
|Basic rate||£11,001 to £43,000||20%|
|Higher rate||£43,001 to £150,000||40%|
|Additional rate||over £150,000||45%|
The rate of tax an individual pay is based on their total taxable income for the tax year. For the tax year ending 5th April 2017 up to 5 th April 2021, the thresholds are shown below.
Looking at the previous example, where the rental profit previously of £1,000, under the new calculation, increases to £5,000. This can place people into the higher rate tax bracket, who weren’t previously.
This is being phased in gradually, the above examples are how it will be calculated once it has been taken full effect in April 2020 onwards. From what has been announced by HMRC, the basic rate deduction (tax relief of 20% of the mortgage interest) will continue for every year after 2020. Prior to that the mortgage interest will be split, with the following percentage being calculated on the old method of calculation and some on the new.
|Tax Year||% of costs deducted from profits (old)||% of costs available as a basic rate deduction (new)|
People who are likely to be impacted by the changes are now starting to buy property in a limited company where the tax rate is currently 19% (set to reduce over the next few years) and interest is treated as a normal cost.
There are a few more factors to consider when deciding if a limited company is the best option such as running costs, additional finance costs, etc. If you would like a full financial comparison of your options please get in touch.