HOW THE RESTRICTION OF RELIEF ON BTL MORTAGE INTEREST WILL AFFECT LANDLORDS

By now I am sure you are all aware of the buy to let “bombshell” within the Chancellor’s Summer Budget – the proposal to allow income tax relief on BTL finance costs at the basic rate of tax only – but I thought it might be helpful to show how this will affect the net (after tax) returns to landlords.

At this stage this is just a “Policy Paper” and I am sure there will be considerable debate with interested parties before this is implemented.  However, for now we have to assume that it will be implemented as proposed starting in 2017/18.

So the good news is that for the next 1.75 years there is no change in the buy to let mortgage interest relief although a separate measure will get rid of the 10% “Wear and Tear” tax allowance for furnished lettings with effect from April 2016.

In looking at the impact of the proposals for interest relief I shall consider only the situation once the proposed measures come into effect fully in 2020/21 – during the preceding three years there is a “tapered” introduction of the measures.  For the sake of easy arithmetic I shall assume that in 2020/21 the personal tax allowance is £12,000 and the basic rate band is £38,000, meaning that the higher rate band starts at £50,000.

Three examples of how it works
So let us consider three examples of somebody who owns a property worth say, £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.

Note the proposed buy to let restriction relates to “finance costs” not just interest – so lender application fees would appear to be covered by the proposals too.

Example 1

Mr A earns a salary (or if self-employed has a taxable profit) of £25,000.   His “before” and “after” situation is as follows.

In other words no change in the overall tax liability for this basic rate taxpayer.  If Mr A was an employee suffering 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 B earns a salary of £75,000.  Her position is altered as follows:

In this case her 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 C 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.

Mrs C 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%).

What should BTL investors do about this?

Landlords with an existing portfolio and who are likely to have additional tax to pay under the proposals have just under two years to consider how best to counter this measure – whether to:

• Sell up, or
• Transfer the property into a limited company (which would involve paying Stamp Duty Land Tax and potentially Capital Gains Tax on the sale – as well as arranging a new mortgage), or
• Do nothing and pay any additional tax.

To discuss how the changes will affect your own tax position, please do not hesitate to contact me on 01925 728234.