The start of the 2017/2018 tax year saw the introduction of controversial new tax relief changes for landlords.
The changes are being tapered in until 2020, at which point landlords will only be able to claim 20 per cent back as tax relief on their mortgage interest.
This will make having a buy-to-let property less profitable for some and in some cases it could cost landlords.
Previously, landlords were only taxed on profits made.
So, for example, if the annual rent was £10,000 and the mortgage interest £9,000, then the profit was £1,000 and this is what the landlord would be taxed on.
However, landlords are losing the right to claim back their mortgage interest costs at the rate they pay income tax – currently up to 45 per cent. Instead, they will see this drop to nothing over the next three years, replaced with a 20 per cent tax credit.
Landlords can now offset only 75 per cent of their mortgage interest against their profits. This falls to 50 per cent next year, 25 per cent in 2019 and zero in 2020.
The full rental income received will be added to the client’s existing income, with the landlord then being charged tax on the total figure.
The stance on wear and tear allowances has also been tightened in recent years.
Landlords can now only claim back wear and tear on actual costs they have incurred, such as replacing furniture.
Previously landlords were able to claim back 10 per cent for the depreciation in value of the property and its furnishings, even if they had not spent anything to replace or improve. Now receipts need to be kept in order to evidence any purchases for wear and tear to the property, and these must be submitted with tax returns to HM Revenue & Customs.
Add all this change to the additional stamp duty charge, a three per cent surcharge introduced last year, throw in the planned 2019 reduction in length for payment of Capital Gains Tax, and it is becoming extremely costly to be a landlord.
Who then are effected by tax relief changes?
• Higher rate tax payers.
• Additional rate tax payers.
• Landlords whose rental profit will put them into a higher tax bracket based on the new calculations.
• Tenants – landlords will try to recoup their lost profits from tenants. This will mainly come via increased rents.
Indeed, higher rate tax payers with mortgage interest above 75 per cent of their total rental income are likely to have their profits wiped out and could end up owing tax. Additional rate tax payers with mortgage interest above 68-70 per cent of their total rental income are likely to be in much the same position.
Many see letting property through a limited company as being a possible way around the new regime.
This is because limited companies have not been affected by the tax changes. A special purpose vehicle (SPV) is easy to set up, focused solely on property letting, and allows for reduced tax.
Main downsides of limited company status are – limited and often more expensive mortgage options, any property already owned in an individual name would need to be bought by the limited company, so additional stamp duty would apply, plus accountants fees to do the accounts.
Another way worth exploring is transferring the property to a spouse/partner/joint property owner who is in a lower tax bracket. But this may take the person into a higher bracket while the individual who transfers over then does not have any legal interest to the property.
Expert tax advice is needed in all cases.