In the Summer Budget of 2015, a number of changes were announced to the tax treatment of buy to let properties. In this article, I will focus on the change to the way in which mortgage interest can be offset against rental income for the purposes of calculating the income tax due on the rent.
At present, it is possible to entirely offset the interest portion of any mortgage that is in respect of a buy to let property, to reduce the taxable profit.
David owns a property which generates £10,000 pa in rental income. He currently pays £6,000 per year on an interest only mortgage that he used to buy the property. Therefore ignoring other allowable expenses, his taxable profit is £4,000 per year. As he is a higher rate tax payer, this is taxed at 40%, giving a net profit protein after tax of £2,400 pa.
With effect from April 2017, this current relief will be phased out, such that from April 2020, only basic rate relief will be allowable.
Continuing the example of David above, David will be taxed on the entire £10,000 at 40% (£4,000). He will then receive a tax credit of 20% of his mortgage payments to offset this liability. This will leave a net profit after tax of £1,200.
As you can see, this change can have a dramatic effect on the profit David is left with, after tax.
This change will be phased in over the next 3 years, such that in year 1, David will still be able to claim 75% of the mortgage interest against the rental income, plus 5% (20%/4) of the mortgage payments as a credit. This can be shown more easily in the table below.
Whilst Buy to Let property investments have been very popular over the past 15 years, there is no doubt that the Chancellor sees landlords as a soft target. This change in taxation, along with the other changes announced including the removal of the Wear and Tear allowance, Stamp Duty surcharge for second residential properties, higher rates of Capital Gains Tax that applies to gains made on residential property, and the shortened period within which any CGT must be paid, the government has very much reduced the attractiveness of residential property as an investment vehicle.
Whilst this change may seem as though it only affects higher rate taxpaying landlords, it could also have the consequence of moving basic rate taxpaying landlords into the higher rate. It is therefore important for landlords with mortgages to plan ahead, and beware of a potentially significant increase in tax liability.