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Background – B2L landlords tax
With effect from April 2017, a buy to let property (B2L) investor will be restricted in the amount of interest relief (and other finance costs) on which they will be able to obtain tax relief.
These restrictions will be phased in over the next four years and will be fully effective from April 2020 onwards. At this time, an investor will merely be able to obtain interest relief at the basic rate of tax.
The rule is somewhat discriminatory in that it only bites in relation individuals, trusts and partnerships. The new rules do not apply to companies.
Also, notably, these changes do not apply to commercial property or furnished holiday lets (“FHLs”).
For many property investors, these interest relief costs will represent their biggest expense and will represent a significant change in the economics of their portfolios – especially for investors who are highly geared.
Basic rate taxpayers are OK?
From the commentary on these changes one might be lead to the conclusion that the new rules do not apply to basic rate taxpayers. This is not the case.
The first step is one must calculate the tax liability of the investor after disallowing the interest costs. This means that the taxable income of the investor, after losing the benefit of the interest deduction, may be pushed in to the higher or additional rate tax bands. Once the tax liability is calculated then one gets a tax credit worth 20% of the interest disallowed at the first step.
Case Study: B2L Landlords tax
Denise has a portfolio of residential properties with gross rents of £120k per annum before interest relief. She has interest payments of 80k per annum. For the tax year 2016/17 she has profits chargeable to income tax of 120k-80k = 40k. This would incur a tax liability £5,800
After the full phasing in:
Denise’s profits will now be £120k. She will have access to basic rate relief on the mortgage interest. Her tax due will be as follows:
Taxable Profits £120,000
Revised Tax Due: £ 41,200
Interest relief: £16,000 [80,000 @ 20%]
Tax Payable: £41,200 – £16,000 = £25,200
The tax liability will have more than quadrupled.
What should I do?
If you, or your clients, are affected by the changes to B2L landlords tax then please do not hesitate to get in touch.