The Budget of 2015: Exploring Buy to Let Taxation
The rules previous to April 2017
Up until April 2017, you could deduct your mortgage interest (plus associated costs like arrangement fees) along with all your other costs before determining your taxable profit.
So as an example:
(The principle is the same for incomes in excess of £150,000 where the higher tax rate of 45% applies)
The new rules:
By the time the new measures have fully taken effect in April 2020, you will no longer be able to deduct mortgage interest costs from your taxable profits if the property is owned by an individual. (If the property is owned as a company, you continue under the old rules and none of this applies.)
Instead, everyone will be able to claim a basic rate allowance for their finance costs — irrespective of their marginal rate.
(This is being phased in over four years, and I'll link to the policy paper for a description of how that works because it's long and a bit distracting.)
Here I will provide an example as we understand the rules to help explain further:
So, a basic rate taxpayer would pay £1,800 tax on that new £9,000 profit, and a higher rate taxpayer would pay £3,600. (Additional rate 45% taxpayers, even more)
However, under the new system, everyone is able to claim a basic rate deduction of 20% of the £5,000 mortgage interest cost in our example. That's £1,000.
So here's the final position if your are.....
A Basic rate taxpayer:
A Higher rate taxpayer:
You'll notice that the basic rate taxpayer ends up paying exactly the same amount of tax under the new system: £800. The higher rate taxpayer, however, ends up paying £1,000 more.
But this doesn't mean that the basic rate taxpayer is unaffected. Because the deduction is applied after calculating the taxable profit, everyone's “profit” has actually increased — from £4,000 to £9,000.
This also means that people whose income (from property plus employment and any other sources) is currently below the higher rate threshold may end up getting pulled into the higher rate band as a result of their higher property “profits”.
Fortunately, the higher rate threshold will have risen from its current £45,000 to £50,000 by the time this measure takes full effect in 2020.
When deciding what to do, we would suggest you work out what effect it will have on your existing or proposed portfolio. The greater your income and the more highly leveraged (mortgaged) you are, the greater the effect – and for some people, it will be really bad. Whilst for others remaining in the lower income band it will not impact so much.
For new landlords, we would suggest you look carefully at setting up a bespoke limited company especialy if you intend to build a portfolio.
For existing landlords with portfolios there are options.
Please note the Government's rules and regulations are likely to change at any time and as professionals familiarise themselves with the legislation variations will be inevitable. This article should not be taken as definitive. Our purpose is to raise the issues and help you choose the right path for you.
As fully independent financial advisers, we have access to the whole of the available buy to let mortgage market and can source your most suitable deal. Please contact us for further information.
Up until April 2017, you could deduct your mortgage interest (plus associated costs like arrangement fees) along with all your other costs before determining your taxable profit.
So as an example:
- £10,000 rental income
- £5,000 mortgage interest costs
- £1,000 other costs
- = £4,000 profit
(The principle is the same for incomes in excess of £150,000 where the higher tax rate of 45% applies)
The new rules:
By the time the new measures have fully taken effect in April 2020, you will no longer be able to deduct mortgage interest costs from your taxable profits if the property is owned by an individual. (If the property is owned as a company, you continue under the old rules and none of this applies.)
Instead, everyone will be able to claim a basic rate allowance for their finance costs — irrespective of their marginal rate.
(This is being phased in over four years, and I'll link to the policy paper for a description of how that works because it's long and a bit distracting.)
Here I will provide an example as we understand the rules to help explain further:
- £10,000 rental income
- [£5,000 mortgage interest costs – NOT DEDUCTED AT THIS STAGE]
- £1,000 other costs
- = £9,000 profit
So, a basic rate taxpayer would pay £1,800 tax on that new £9,000 profit, and a higher rate taxpayer would pay £3,600. (Additional rate 45% taxpayers, even more)
However, under the new system, everyone is able to claim a basic rate deduction of 20% of the £5,000 mortgage interest cost in our example. That's £1,000.
So here's the final position if your are.....
A Basic rate taxpayer:
- 20% tax on £9,000 profit = £1,800
- Minus £1,000 deduction (20% of £5,000 interest cost)
- = £800 tax to pay
A Higher rate taxpayer:
- 40% tax on £9,000 profit = £3,600
- Minus £1,000 deduction (20% of £5,000 interest cost)
- = £2,600 tax to pay
You'll notice that the basic rate taxpayer ends up paying exactly the same amount of tax under the new system: £800. The higher rate taxpayer, however, ends up paying £1,000 more.
But this doesn't mean that the basic rate taxpayer is unaffected. Because the deduction is applied after calculating the taxable profit, everyone's “profit” has actually increased — from £4,000 to £9,000.
This also means that people whose income (from property plus employment and any other sources) is currently below the higher rate threshold may end up getting pulled into the higher rate band as a result of their higher property “profits”.
Fortunately, the higher rate threshold will have risen from its current £45,000 to £50,000 by the time this measure takes full effect in 2020.
When deciding what to do, we would suggest you work out what effect it will have on your existing or proposed portfolio. The greater your income and the more highly leveraged (mortgaged) you are, the greater the effect – and for some people, it will be really bad. Whilst for others remaining in the lower income band it will not impact so much.
For new landlords, we would suggest you look carefully at setting up a bespoke limited company especialy if you intend to build a portfolio.
For existing landlords with portfolios there are options.
- Set up a company and sell your properties to it – although this will trigger CGT and Stamp Duty liabilities, and you'll need to remortgage, which will also involve further costs. There are schemes suggested by some legal firms to avoid stamp duty. This usually involves a two step transfer into an LLP before the limited company.
- Sell properties that are no longer profitable
- Attempt to cut costs to offset the extra tax you'll be paying
Please note the Government's rules and regulations are likely to change at any time and as professionals familiarise themselves with the legislation variations will be inevitable. This article should not be taken as definitive. Our purpose is to raise the issues and help you choose the right path for you.
As fully independent financial advisers, we have access to the whole of the available buy to let mortgage market and can source your most suitable deal. Please contact us for further information.
