Buy-to-let tax relief is changing from 2017 – how will this affect higher-rate taxpaying owners?
New rules for buy-to-let
The Chancellor’s Summer Budget contained a number of surprises, but one of the biggest was the plan to reduce tax relief on buy-to-let properties, which may significantly impact rental property owners who pay higher rate tax.
This change will begin in 2017 and be phased in over a four-year period. Once fully effective, higher rate taxpayers will only benefit from the basic rate of tax, which is 20%, when offsetting their mortgage interest against their rental income. Currently, for example, if a higher rate tax payer pays 40% tax on their rental income, they can offset this with tax relief of 40% of their mortgage interest.
So what does this mean for buy-to-let property owners? If they currently benefit from mortgage interest tax relief above 20%, they’ll receive less profit once the new rules come into play. For some (mainly those with lower deposits), the changes may even mean they’ll be making a loss on their rental income.
Examining the figures
This is explained best by crunching the numbers.
Say you have a property worth £350,000 with a 5% interest-only mortgage of £300,000. Currently, you pay £15,000 in mortgage interest, and you receive £18,000 in rent. You are charged 40% tax on your rental income, which is £7,200. But you receive tax relief on this of 40% of your mortgage interest payments, which is £6,000.
So the actual tax you pay is £1,200 (£7,200 minus £6,000). This means that the profit you make on your rental property, once you’ve deducted your mortgage interest payments and tax payments from your rental income, is £1,800 (£18,000 minus £15,000 minus £1,200).
However, under the new rules, once your tax relief is fully reduced your profit would become negative and you’d actually be making a loss. Instead of receiving tax relief at 40%, which is £6,000, your tax relief would fall to 20%, which is £3,000.
This means your tax bill would rise, as the tax due on your rental income stays at 40%, ie £7,200, with only £3,000 tax relief to offset this. Leaving you with a tax bill of £4,200 (£7,200 minus £3,000). So when your rental income of £18,000 is now subject to £15,000 in mortgage interest payments and £4,200 in tax, you’re left with an annual loss of £1,200.
And if interest rates rise from their current historic low, some landlords may feel more financial pressure.
So what now?
There are a number of possible options – some of which have complex tax implications and would need the help of an adviser. However, there are also some simpler approaches. For example, if your mortgage isn’t interest-only, your investment may still be worthwhile if the property’s value is set to rise and eclipse the loss on your rental income. Alternatively, if you can increase your deposit, you may be able to lower your mortgage interest payments and turn your rental income back into profit.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest.