Changes to buy-to-let tax relief

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Following former Chancellor George Osbourne’s decision to tighten the purse strings on the profitability of the buy-to-let sector, some landlords across the UK have seen their taxes rise, their profits decrease and their choice of buy-to-let mortgages restricted as lenders increase their interest coverage ratios.

Up until April 2017, landlords could claim tax relief on their mortgage payments. For example, if a landlord collects £10,000 a year rental income but pays mortgage interest of £9,000, they only pay tax on the £1,000 profit at their current income tax band. For a 40% taxpayer, this would be £400.

By the time the new measures have fully taken effect in April 2020, when mortgage interest tax relief will have been cut back to 20%, landlords will have to pay tax on the full amount of rental income received, rather than what’s left over after their mortgage interest has been paid, less a 20% credit on the mortgage interest.

As per the above example, for a 40% taxpayer, the tax bill would now work out to be £4,000 (40% of £10,000) minus £1,800 (20% of the £9,000 mortgage interest), equalling a final tax bill of £2,200, up from £400 under the old regime.

Whilst those in the basic rate tax bracket would pay the same under both systems, because the deduction is applied after calculating the taxable profit, their profit has still increased – in this example from £1,000 to £9,000. This means any landlord whose income (from property plus employment and any other sources) is currently below the higher rate threshold, may get pushed into the higher rate band as a result of their higher property “profits”.

One small glimmer of light is that limited companies are not affected by the changes. Many landlords are therefore considering setting up a company to minimise the impact of the new tax regime. However, any transfer of ownership (even between yourself and your limited company) will be treated by the HMRC as a sale, which will trigger CGT and Stamp Duty liabilities, and require you to remortgage. More on remortgaging a little further below.

As a result of these new restrictions on mortgage tax relief, an increasing number of lenders have already started demanding a higher rental coverage of 145 percent – up from the norm of 125 percent. This strategy has been introduced in a bid to deliver more responsible lending using tighter controls for affordability assessments, with a view to ensuring landlords can keep up their repayments based their new, reduced profit margins.

The move by lenders follows HM Treasury’s decision to grant the Bank of England new powers to place limits on the loan-to-value ratios and interest coverage ratios that lenders must adhere to. Whilst a move towards more sensible lending can only be viewed as a positive, concerns have been raised that some landlords may not be able to remortgage having attained their original mortgage based on the lower 125 percent coverage.

Adding to landlords’ woes, the Chancellor also imposed tighter restrictions on what landlords can claim as ‘wear and tear’. As of April 2016, landlords can no longer automatically deduct 10% of their rental profits as notional wear and tear, which many did even if they hadn’t spent a penny on renovating their properties. Whilst they can still offset some maintenance costs, they are now only able to deduct costs they actually incur and will need to keep receipts as proof of that expenditure.

If you have any concerns about how these changes may affect your annual tax calculations, please contact your Finura Partners adviser.

Articles on this website are offered only for general informational and educational purposes. They are not offered as and do not constitute financial advice. You should not act or rely on any information contained in this website without first seeking advice from a professional. Capital is at risk; investments and the income from them can fall as well as rise.

Sources:
https://www.ftadviser.com/mortgages/2016/11/29/more-lenders-predicted-to-raise-rental-coverage-demands/
http://www.propertygeek.net/budget-2015-mortgage-interest-relief-changes-explained/

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