Income Tax relief for mortgages – don’t get caught out
In the Budget on 8th July 2015 George Osbourne announced plans to restrict the Income Tax relief currently available to individuals on finance costs for ‘buy to let’ properties. This policy is intended to ‘ensure that landlords with higher incomes no longer receive the most generous tax treatment’.
From 6th April 2017, only 75% of the financing costs can be claimed against rental income and therefore relievable at the marginal tax rate. For the remaining 25%, basic rate tax relief at presently 20% will be available as a deduction from income tax liability.
Over the next two tax years, the percentages reduce to 50%/50% then 25%/75% and from 6th April 2020 the tax relief on the whole of the financing costs will be restricted to basic rate tax only.
It has been widely reported that landlords liable to basic rate tax only will not need to worry but this is not strictly true and is illustrated by the following example. For the calculations, the rates and allowances for the 2015/16 tax year have been used.
A landlord who owns 4 rental flats with rental income of £37,000 per year, mortgage interest of £21,000 per year, repair costs of £4,000 per year and employment earnings of £27,000 per year:
Under current rules the taxable rental income would be £15,000 as the landlord is a basic rate taxpayer. The total tax on the rental and employment earnings would therefore be £6,280. Under the new rules from 2020/21 onwards, the taxable rental income in the same circumstances rises to £36,000, with a total tax bill of £10,403.
If interest rates were to increase in the future which is more likely than not, the situation would be even worse. In this case the tax paid could actually result in the landlord making a loss.
A 2% interest rate rise would mean that the mortgage interest would increase to £31,800 per year so the actual profit on the rental properties before tax would be £4,200. Under the new rules the landlord would still have to report taxable profit of £36,000 resulting in a total tax bill of £8,243 (of which £4,963 relates to rental income). This would result in a loss on the rental properties of £763.
Going forward it will be of the utmost importance to manage rental portfolios tax efficiently. This is particularly important where there are high loan to value mortgages with the possibility of Bank of England base rate rises in the future. Landlords should take professional advice to mitigate the effect of these tax changes.Business, General, George Ide, News