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Buy to Let (“B2L”) Landlords: Losing interest?

Author

Sharon Collier

An experienced Chartered Tax Adviser and Trust and Estate Practitioner, Sharon joined ETC Tax in September 2016.

Introduction

If you are a B2L Landlord, you are probably aware of some seismic changes which were announced in 2015 restricting the value of mortgage interest relief.

In short, higher rate tax relief is restricted for buy-to-let landlords on the costs of finance from 6 April 2017 onwards.

What you need to know

  • The change is being phased in over three years commencing 6 April 2017.
  • It means that all finance costs (not just loan interest) will no longer be an allowable expense when calculating your taxable rental profits.
  • individual landlords are required to make a tax return adjustment.
  • The adjustment will give you a basic rate tax deduction after the rental profits have been taxed. This deduction will be up to 20% of the finance cost.
  • Unfortunately, this measure will impact on all taxpayers who incur finance costs who report rental business, under Self-Assessment and not just higher rate taxpayers.
  • Finance costs include mortgage interest, any payments that are equivalent to interest, and incidental costs of obtaining finance, such as fees and commissions, legal expenses for negotiating drafting loan agreements or valuation fees required to provide security for a loan.

Are all landlords affected?

  • These new rules only apply to individuals with residential property businesses.
  • They do not apply to companies.
  • They do not apply to land and property dealing or development businesses, commercial lettings or furnished holiday lets.

Complications for basic rate taxpayers

  • If you are currently a basic rate taxpayer, you may find that you are a higher rate taxpayer, once the finance costs are disallowed in your rental accounts.
  • Your tax liability depends on your other income and the amount of finance costs that are added back.
  • You will not know whether the adjustment will take you into higher rate tax without going over a series of steps in order to work out the effect of the change.
  • If you do become a higher rate taxpayer after arriving at your rental profits, you will lose higher rate tax relief on your finance costs.
  • You continue to receive basic rate tax relief on your other costs.

Practical considerations:

  • The increase in rental profits will lead to an increase in your total income for tax.
  • The knock on effects depend on your personal circumstances, other income, capital gains and other reliefs.
    • For example, there is an impact for anyone claiming tax credits or if you or your partner claim child benefit and the change increases your income above £50,000, child benefit can be clawed back under the Higher Income Child Benefit Charge (HICBC).
  • You could find that you are paying tax at 40% or higher or that capital gains are taxed at 28% instead of 18% (on residential disposals).
  • You may be able to reduce your taxable income if you carry back pension contributions or Gift Aid donations from the next year.

Case Study

Denise

  • Portfolio of residential properties
  • Gross rents, £120k per annum before interest
  • Interest of £80k per annum
  • For 2015/16 – Rental profit, £40k and pays tax of £5,880 (all within BRT)
  • With the new rules (in full operation) Denise would have:
    • Revised tax payable: £41,403
    • Interest relief: £(16,000) [£80k x 20%]
    • Revised Tax payable: £25,403

Denise

  • Portfolio of residential properties
  • Gross rents, £120k per annum before interest
  • Interest of £80k per annum
  • For 2015/16 – Rental profit, £40k and pays tax of £5,880 (all within BRT)
  • With the new rules (in full operation) Denise would have:
    • Revised tax payable: £41,403
    • Interest relief: £(16,000) [£80k x 20%]
    • Revised Tax payable: £25,403

What should I do?

If you are affected by these changes we would recommend that you speak to your accountant or to one of the advisers at Enterprise Tax Centre with any queries

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