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.