Income Tax in View of Chancellor’s New Buy-to-Let Tax Proposal
Care4Properties has prepared the following blog for landlord. The simple explanation of the Chancellor’s buy to let “bombshell” is as follow:
- The interest portion of the mortgage payment is currently allowed to be deducted from the rental income in order to calculate rental income and related income tax. The Chancellor is proposing that the landlords should not be able to deduct this interest portion from the rental income and instead should claim relief from the tax liability. It can be explained in a very simple example:Let’s say Mr Oakwood owns a house which he is rented on annual rent of £17,000. His mortgage payment is £15,000 but the interest portion of this mortgage payment is £9,000. He has other costs of £2,000 relating to the management of this house. He has a salary income of £30,000 as well.
| Existing Situation | New Situation (from 2020/21) | ||
| Rental Income | 17,000.00 | Rental Income | 17,000.00 |
| Less: Mortgage Interest | – 9,000.00 | Less: Mortgage Interest | – |
| Less: Other Costs | – 2,000.00 | Less: Other Costs | – 2,000.00 |
| Net rental Income | 6,000.00 | Net rental Income | 15,000.00 |
| Salary Income | 30,000.00 | Salary Income | 30,000.00 |
| Total Income | 36,000.00 | Total Income | 45,000.00 |
| Tax calculation: | Tax calculation: | ||
| on £10,600 (0%) | – | on £10,600 (0%) | – |
| On £25,400 (20%) | 5,080.00 | On £31,785 (20%) | 6,357.00 |
| On £2,615 (40%) | 1,046.00 | ||
| Less: 20% interest relief | – 1,800.00 | ||
| 5,080.00 | 5,603.00 | ||
Mr. Oakwood will be paying £523.00 more every year under the proposed changes if the income level stays the same. Dis-allowing the interest cost from his income has made part of his income liable to higher rate tax. There would have been no consequences for him if his income would have been lower than the higher rate threshold. Let’s explain this in the example. Suppose Mr Oakwood salary was £25,000.
| Existing Situation | New Situation (from 2020/21) | ||
| Rental Income | 17,000.00 | Rental Income | 17,000.00 |
| Less: Mortgage Interest | – 9,000.00 | Less: Mortgage Interest | – |
| Less: Other Costs | – 2,000.00 | Less: Other Costs | – 2,000.00 |
| Net rental Income | 6,000.00 | Net rental Income | 15,000.00 |
| Salary Income | 25,000.00 | Salary Income | 25,000.00 |
| Total Income | 31,000.00 | Total Income | 40,000.00 |
| Tax calculation: | Tax calculation: | ||
| on £10,600 (0%) | – | on £10,600 (0%) | – |
| On £20,400 (20%) | 4,080.00 | On £29,400 (20%) | 5,880.00 |
| Less: 20% interest relief | – 1,800.00 | ||
| 4,080.00 | 4,080.00 | ||
So it is clear that the higher the mortgage interest amount is the higher the extra tax will be. If you own a buy to let property which is fully paid, there are no consequences for you under these changes.
- The proposed changes are to be fully implemented from 2020/21 but “tapered” introduction will start from 2017/18. Let’s assume that Mr Oakwood earns the exact same amount of money every year:
| Current | 2017/18 | 2018/19 | 2019/20 | 2020/21 | |||||
| Rental Income | 17,000.00 | 17,000.00 | 17,000.00 | 17,000.00 | 17,000.00 | ||||
| Less: Mortgage Interest | – 9,000.00 | – 6,750.00 | – 4,500.00 | – 2,250.00 | – | ||||
| Less: Other Costs | – 2,000.00 | – 2,000.00 | – 2,000.00 | – 2,000.00 | – 2,000.00 | ||||
| Net rental Income | 6,000.00 | 8,250.00 | 10,500.00 | 12,750.00 | 15,000.00 | ||||
| Salary Income | 30,000.00 | 30,000.00 | 30,000.00 | 30,000.00 | 30,000.00 | ||||
| Total Income | 36,000.00 | 38,250.00 | 40,500.00 | 42,750.00 | 45,000.00 | ||||
| Tax calculation: | |||||||||
| on £10,600 (0%) | – | – | – | – | – | ||||
| On £25,400 (20%) | 5,080.00 | – | – | – | – | ||||
| On £27,650 (20%) | 5,530.00 | – | – | – | |||||
| On 29,900 (20%) | 5,980.00 | – | – | ||||||
| On 31,785 (20%) | 6,357.00 | 6,357.00 | |||||||
| On £365 (40%) | 146.00 | ||||||||
| On £2,615 (40%) | 1,046.00 | ||||||||
| Less: 20% interest relief | – 450.00 | – 900.00 | – 1,350.00 | – 1,800.00 | |||||
| 5,080.00 | 5,080.00 | 5,080.00 | 5,153.00 | 5,603.00 | |||||
- These changes are not applicable if you own buy to let properties through a company.
- These changes are only applicable to residential properties. Chancellor has spared the commercial properties.
At this stage this is just a “Policy Paper” and I am sure there will be considerable debate with interested parties before this is implemented.
Way Forward?
If you are considering buying a new rental property with a buy to let mortgage then you should consider making the investment through a limited company as there is currently no proposal for restricting the deduction of financing costs within companies. Whilst there are some costs associated with running a limited company these are small compared with the potential savings.
Landlords with an existing portfolio and who are likely to have additional tax to pay under the proposals have just under two years to consider how best to counter this measure – whether to:
- Sell up, or
- Transfer the property into a limited company (which would involve paying Stamp Duty Land Tax and potentially Capital Gains Tax on the sale – as well as arranging a new mortgage), or
- Do nothing and pay any additional tax.
We advise all clients to take their own tax advice as we do not know the detail of clients’ tax affairs.
If you would like us to review your buy to let portfolio to see where savings could be made or if you have any question regarding these changes, please email us on [email protected]. This service is free of charge and without obligation.