No more mortgage interest relief for landlords
As of April 2017, there has been a change to the level of tax relief that landlords who have residential properties receive, with this now being limited to the basic rate of income tax. This process is being phased in over four tax years, beginning on the 6th of April 2017 with the new system being completely in place from the 6th of April 2020.
For the current tax year, 2017/18, 75% of mortgage interest is allowed at the full rate while the remaining 25% is available at the basic rate. In the following tax year, 2018/19, 50% of mortgage interest will be allowed while the remaining 50% is available at the basic rate. For the 2019/20 tax year, 25% of mortgage interest is allowed at the full rate while the remaining 75% is available at the basic rate. For the tax year of 2020/21 and beyond, mortgage interest deduction will only be available at the basic rate.
It should be noted that the restriction in mortgage interest relief will not apply to properties which are classed as “furnished holiday lets” or commercial properties. As with all things financial, the overall impact on a landlord, and the economy and people as a whole, stretches beyond the mortgage interest relief rate.
Landlords should be aware of their tax bracket
It should also be noted that this new measure sees the interest cost being removed with a tax credit of 20% being applied against the income tax liability for an individual. This is important because it may see some landlords being into a higher tax bracket. A landlord that is pushed into a higher tax bracket than they are currently in, moving from the 20% to the 40% bracket or from the 40% to the 45% bracket, there could be serious financial consequences for the landlord.
HMRC believes that over 80% of landlords will be unaffected by these changes, and this relates to landlords who are currently in the basic rate tax bracket and the change in tax liability doesn’t place them into a higher tax bracket. However, the remaining percentage of landlords who are moved into a higher rate threshold or who are in the upper two brackets will find that the level of tax they have to pay will increase and this can lower their net income. Depending on the personal circumstances of the landlord, this decrease in income may actually have a negative impact on them, so it is essential that each landlord reviews these changes and what overall impact it will have on them.
Some landlords will be unaffected by the change
The changes can probably be best understood with a number of examples, starting with the old state of affairs. A landlord that has a rental income of £10,000 for a year but pays mortgage interest of £9,000 is left with a profit of £1,000. A landlord in the basic rate of tax bracket, 20%, would pay £200 tax on this profit, being left with £800. A landlord in the 40% bracket would pay £400 tax being left with a profit of £600 and a landlord in the 45% rate would pay £450 tax, leaving them with a £550 profit.
The impact of this change can be seen in the following example.
A landlord who is in the higher rate of tax bracket would end up facing a tax bill of £4,000 (which is 40% of their £10,000 profit) minus £1,800 (which is 20% of the interest figure) and this leaves them with a tax liability of £2,200. Before the system changed, this landlord had a tax bill of £400, but after the system is fully implemented, they will be forced to pay out an additional £1,800 in tax each year.
The same is true for a landlord in the additional tax bracket rate. Previously, this landlord would have faced a tax bill of £450 but after the changes, their tax liability would be £2,700. This is a large increase and it is important that landlords are aware of how much their finances could change due to the removal of mortgage interest relief.
There is also the fact that holding a higher level of taxable income can impact on personal allowance (if the income is pushed beyond £100,000) and it could affect a person’s right to access child benefit or enjoy tax relief on pensions. This is why it is essential that landlords look at their finances as a whole, including their expected rental yields, and determine what the outcome for them will be.
The removal of mortgage interest relief for landlords is a huge factor that landlords need to consider in reviewing their finances. The fact that the process is being phased in over four years may help to spread the harshest nature of the impact but it is something that landlords need to be aware of now, and also know that the formula changes every year until the scheme is fully implemented in April 2020.