April is just around the corner, with the changes in landlord taxes due to come in. Buy to let landlords are set for potentially big increases in their tax payments, but what exactly are they, who do they affect and how can they be avoided?
What are the changes?
The amount of Income Tax relief that landlords can claim on residential property finance costs will be restricted to the basic rate of tax. So rather than paying tax on profits, having deducted mortgage interest payments, landlords will soon pay tax on all their rental income, minus a basic tax credit.
Imagine you are a landlord with a buy to let mortgage. You have an annual rental income of £10,000 and annual mortgage interest payments of £8,000.
As things stand, you can deduct your £8,000 mortgage interest from your rental income and you only have to pay tax on the £2,000 that are left over. If you are in a high tax bracket, such as 40% for example, that means paying 40% on £2,000 which is £800.
As of April, the changes being introduced mean that you will eventually have to pay 40% on the full £10,000 and you will only be able to deduct 20% of the mortgage interest. So you will have to pay 40% on the full £10,000 rental income (£4,000) and only be able to deduct 20% of the interest repayment amount (20% of £8,000 = £1,600) resulting in a tax bill of £2,400. That’s a big difference!
Who will they affect?
The changes will not affect everyone, and those who are affected will be so to varying degrees.
The changes are applicable to mortgage interest payments so landlords with no mortgage will not be affected at all. Those with high interest rates will be most affected.
Similarly, the changes apply to income tax payments, so those in the higher income brackets will be worst affected by the changes:
Imagine the landlord receiving £10,000 was in the 20% tax bracket. As things stand, he has to pay 20% on his £2,000 which is £400. Under the new rules, he will have to pay 20% on £10,000 which is £2,000 minus the 20% tax break which is £1,600 so he will still pay £400.
Those affected will be people who:
Let residential properties as an individual, or in a partnership or trust
Are UK residents who let residential properties in the UK or overseas
Are non-UK residents who let residential properties in the UK
Are trustees or beneficiaries of trusts liable for Income Tax on the property profits
Have finance costs (mortgage interest, loans, overdrafts, premiums or disguised interest)
Those NOT affected by the introduction of the finance cost restriction will be:
UK resident companies
Non-UK resident companies
Landlords of Furnished Holiday Lettings
Landlords without a mortgage or loan
It is worth noting that there is a transitional period, and landlords will still be able to deduct some of their finance costs during this period. These deductions will be gradually withdrawn and replaced with the basic rate relief tax reduction by 2020.
Other restrictions on reliefs
The tax changes affecting landlords are unfortunately not restricted to mortgage interest. Tighter restrictions on the wear and tear allowance have meant that landlords can no longer automatically to deduct 10% of rental profits but can only claim tax relief on actual repairs made and for which they have receipts.
All of this in addition to the stamp duty surcharge for landlords announced in the Autumn Statement as well as the requirement for landlords to pay capital gains tax on any profits within 30 days of selling a property from April 2019.
How it can be avoided
Limited companies are not affected by the changes to mortgage interest tax relief. Landlords could therefore move their assets into a company structure. However, such a move may incur a capital gains tax payment, and mortgage options for companies might also be limited. Alternatively, a landlord could transfer property ownership to a spouse or partner who is in a lower tax band, bearing in mind this could also have capital gains tax implications, and/or lift the spouse into a higher tax bracket.