Investing in property has been a very popular choice of investment by individuals for a number of years, whether they hold a large portfolio or simply own a single rental property.
Recent changes to tax legislation in this area however has meant that current or future rental property owners have to carefully review their tax position to ensure their investments achieve the desired financial benefits.
The changes to rental property tax
The first major change was an increase to stamp duty payable. An individual purchasing a new property that results in them owning more than one residential property is now subject to an increase of 3% on each stamp duty tier the property falls in to.
The second change saw the removal of the ‘wear and tear’ allowance for furnished rental properties. This was replaced with a new ‘renewals allowance’, available on both unfurnished and furnished rental properties.
The third significant change that came into effect from 6 April 2017 was the restriction of tax relief on mortgage and other finance interest. Prior to this date, 100% of any interest paid towards the mortgage or finance repayments could be deducted from the rental income before tax was paid on the remaining amount.
Changes to tax relief on mortgage and finance interest
The new buy-to-let tax system was first introduced for the 2017/18 tax year but is being phased in year by year until 2020, when the rules will be fully in place.
In the 2017/18 tax year, the percentage of mortgage and finance interest payments deductible from rental income reduced to 75%, with a basic rate tax (currently 20%) credit being given for the remaining 25% that was not deducted from the rental income.
The transition period reduces the amount of mortgage and other finance interest that can be fully deducted against rental profits for the next few years. This means that under the new tax system the allowable interest deduction will be 50% in 2018/19, 25% in 2019/20, after which no deduction will be available from 2020/2021 but will be replaced with the basic rate tax reducer.
This has the potential to push basic rate taxpayers into the higher tax band and further compound the misery for higher and additional tax rate payers who will see the return on their investments squeezed as rental profits will be higher without the interest deduction.
How the changes to tax relief could impact a taxpayer
To illustrate the impact these changes could have, let’s take Mrs A, a higher rate taxpayer, as an example.
In 2020/21, Mrs A received rental income of £9,000. After deducting £6,000 worth of mortgage interest, her rental profits were £3,000.
Under the old rules, her tax liability would have been 40% (the current tax rate for higher rate taxpayers) of her £3,000 rental profits, so £1,200.
Using the new rules in 2020/21, these will be full force and therefore no deduction is allowable for the mortgage interest. This means that her rental profits will be £9,000. Mrs A’s tax liability becomes 40% of £9,000, a total of £3,600.
Under the new system however, you can then deduct the 20% mortgage interest relief from the liability calculated, which amounts to £1,200 (20% of the £6,000 mortgage interest).
The tax liability minus the interest relief is therefore £2,400 (a £3,600 liability - £1,200 of relief).
The final tax payment of £2,400 equates to 80% of the rental profits, instead of 40% pre-2017!
It should be pointed out that basic rate taxpayers should not see any impact on their final tax position, however higher and additional tax rate payers will see an increase in the tax liability due.
How to reduce the impact of the changes
To mitigate against these changes, many landlords are considering transferring existing properties to a corporate entity, or purchasing them as such from the outset. If the property isn’t owned by an individual, the mortgage interest can be claimed in full at the time of writing.
Additionally, the mortgage and finance interest restriction does not affect furnished holiday lets or serviced accommodation. More individuals appear to be considering these properties for future investments as there are potential tax savings available, such as capital allowances. There are certain criteria however that need to be met to qualify as a furnished holiday let or serviced accommodation.
Getting advice from a professional
If you are affected by any of these changes, please ensure you speak with a professional adviser.
Every individual’s circumstances and aims are different so these should be taken into consideration to ensure that the most efficient structure is put in place.
Get in touch with Denny from Honey Barrett -
Phone 01323 412277 or,
visit the website at https://www.honeybarrett.co.uk/