If you are a buy to let landlord, you will have been able to claim full tax relief on interest and other borrowing costs. However, this is being restricted to basic rate tax relief. The process starts in April 2017 and is being phased in over three years:
2017/18 – 25% restriction
2018/19 – 50% restriction
2019/20 – 75% restriction
2020/21 – 100% restriction
This affects mortgage interest, loan interest and the cost of any products when a mortgage or loan is first taken out.
The best way to illustrate this is by way of an example. David is a buy to let landlord and has several properties. He receives £60,000 in rent after all running costs but before mortgage interest. His mortgage interest is £34,000, which usually gives him a taxable profit of £26,000. This is well below the higher rate tax threshold of £43,000, so he only pays standard rate income tax.
If we assume the same figures – income, personal allowances, and tax rates and tax bands - for the next four tax years, he will be unaffected by the changes in 2017/18 and 2018/19. In 2017/18, the interest which is allowable for income tax purposes is £34,000 x 75% = £25,500. This will give him an extra tax liability. However, this is then reduced by a ‘tax reducer’ of the restriction at the normal tax rate – i.e. £8,500 x 20% = £1,700. This gives him the same tax liability. This is also the same story for 2018/19.
However, in 2019/20, the interest available for the initial tax relief doesn't stop David’s income going over the higher rate tax threshold, so some of his taxable income is taxed at 40%. The tax reducer isn’t sufficient to cover this, so he has an extra tax bill (£1,700 extra for the 2019/20 tax year). There is a similar scenario for 2020/21.
The following table shows the full picture of how the restriction can increase your tax liability:
| 16/17 | 17/18 | 18/19 | 19/20 | 20/21 | ||
| £ | £ | £ | £ | £ | ||
| Rent | 60,000 | 60,000 | 60,000 | 60,000 | 60,000 | |
| Interest | 34,000 | 34,000 | 25,500 | 17,000 | 8,500 | 0 |
| Profit | 26,000 | 34,500 | 43,000 | 51,500 | 60,000 | |
| Tax calculation | ||||||
| Profit | 26,000 | 34,500 | 43,000 | 51,500 | 60,000 | |
| Personal allowance | 11,000 | 11,000 | 11,000 | 11,000 | 11,000 | |
| Taxable | 15,000 | 23,500 | 32,000 | 40,500 | 49,000 | |
| @ 20% | 15,000 | 23,500 | 32,000 | 32,000 | 32,000 | |
| @ 40% | 0 | 0 | 0 | 8,500 | 17,000 | |
| Total tax | 3,000 | 4,700 | 6,400 | 9,800 | 13,200 | |
| Less tax reducer | 34,000 | 1,700 | 3,400 | 5,100 | 6,800 | |
| Tax bill | 3,000 | 3,000 | 3,000 | 4,700 | 6,400 |
As you can see, David's tax liability more than doubles as the tax relief on interest is restricted. NB this scenario covered someone who only had buy to let income, but it can, of course, affect anyone who has buy to let income as part of their taxable income and has mortgage interest as a deduction.
Buy to let investments have become a viable alternative to a pension for many individuals. This latest attack on landlords will create a real problem. It may even mean that landlords who make a loss will end up paying tax. If you are a buy to let landlord and need help understanding how the changes may affect you, please do not hesitate to get in touch.
Further information from HMRC is available here.
