August 15, 2016
Property gossip August 2016

George Osborne may no longer be Chancellor of the Exchequer; however he had made several tax changes, which directly impact the PRS, with arguably the biggest of them all still to come.

Landlords currently enjoy tax relief on mortgage interest; however April 2017 will see the start of a 4 year plan to change this, with the potential to push lower rate tax payers into a higher rate of taxation.

The changes will be phased in as follows:

  • In the 2017/2018 financial year, the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs e.g. mortgage interest, with the remaining 25% qualifying for a “capped” 20% “tax reducer”
  • In the 2018/2019 financial year, that figure of 75% will become 50% (with the remaining 50% qualifying for a “capped” 20% “tax reducer”)
  • In the 2019/2020 financial year, the figure of 50% will become 25% (with the remaining 75% qualifying for a “capped” 20% “tax reducer”).
  • As from 2020/2021 all financing costs e.g. mortgage interest, incurred by a landlord will only qualify for a “capped” 20% “tax reducer”.

If your total earnings e.g. salary/income, plus your rental income profits, fall beneath the basic rate of tax, you will pay tax at 20% on the relevant percentage of your mortgage interest – until April 2020 when that percentage becomes 100%. You will be entitled to a 20% tax reducer on the taxable mortgage interest so as a basic rate tax payer it will not have an effect. However, if you are already a higher rate tax payer, or as a result of the tax change you suddenly find that you have become a higher rate tax payer, then your position will of course worsen.

Below is an example of how a basic rate tax payer could become a higher rate tax payer. The significance is that come April 2020 you will pay 40% tax on your rental profit, but only receive the tax based tax reduction at a “capped” level of 20%.

This example is based on the following:

  • An employment income of £35,000 p.a., with no other income apart from rental profits.
  • A tax allowance figure at £11,000 p.a., leaving a taxable sum of £32,000 p.a.
  • A rental income of £20,000 p.a., with £5,000 of legitimate, fully allowable expenses.
  • £10,000 in mortgage interest paid annually.
To 2016/17 2017/18 2018/19 2019/20 2020/21 & on
Rents Received £20,000 £20,000 £20,000 £20,000 £20,000
Allowable Costs £5,000 £5,000 £5,000 £5,000 £5,000
Profit Before Interest £15,000 £15,000 £15,000 £15,000 £15,000
Mortgage Interest Deductible £10,000 £7,500 £5,000 £2,500 £0
Taxable Profit £5,000 £7,500 £10,000 £12,500 £15,000
Employment Income + Rental profits £40,000 £42,500 £45,000 £47,500 £50,000
Less Personal Allowance £11,000 £11,000 £11,000 £11,000 £11,000
Taxable Income £29,000 £31,500 £34,000 £36,500 £39,000
Tax at 20% £5,800 £6,300 £6,400 £6,400 £6,400
Tax at 40% £800 £1,800 £2,800
Less Tax Reducer: N/A
20% of £2,500 -£500
20% of £5,000 -£1,000
20% of £7,500 -£1,500
20% of £10,000 -£2,000
Tax Payable £5,800 £5,800 £6,200 £6,700 £7,200
Difference vs 2016/17: £0 £400 £900 £1,400

Based on the example above you can see how the landlord is pushed into a higher tax bracket as the changes are phased in. Also to consider is the removal of a 10% tax allowance for fair wear and tear on furnished lettings along with the new way taxable income will be calculated, for those in receipt of child benefit, they may suddenly find their child benefit is taxable if their total income goes over £50,000.

It could be argued that the level of personal tax allowance will increase each year, so as to keep pace with the phasing in of the tax changes on mortgage interest payments; however, personal tax allowance figures are not set in stone and in any case they are unlikely to make a difference for those landlords already in the higher tax bracket e.g. perhaps those with more than one rental property.

You can see how the new rules will in the vast majority of cases result in landlords paying more tax and making less profit, with some landlords actually making a loss. This would put more pressure on rental prices, which is why many are calling this “the tenant tax”.

This tax change will affect the whole country so it’s not a “London problem” – we could see rents rise on a national scale.

Whilst we are told that the idea behind all of this was to give homebuyers a fairer chance in the buying market, the vast number of properties we sell are sold to homeowners and price rises in recent years was down to overall demand, not due to landlord investors squeezing out would-be homeowners. It may be different elsewhere in London / the country, but it’s hard to see these changes as anything other than a tax raising exercise and we have a new Chancellor, who will deliver his first Autumn Statement later this year, in which taxation plans / changes are likely to be announced (could they scrap these tax plans, or perhaps go the other way and speed up the phasing in process??).

There is a campaign to start a legal process (called a judicial review), to stop these tax changes from ever coming into force. You can find more information on this subject and the progress of the judicial review by clicking on this weblink

If you have any questions concerning the new tax rules, and/or in relation to tax in general, simply e-mail your question/query and we will put you in touch with a suitably qualified expert