The restriction is being phased in over 4 years and it commenced in April 2017. The first tax year that is affected is therefore 2017/2018, and this article is to remind residential landlords about the tax implications of the new rules.
Old rules
Under the old rules, mortgage interest was allowed as a deduction against rental income when calculating net taxable rental profits. Therefore landlords could obtain tax relief for mortgage interest at 40% or even 45%.
New rules
Under the new rules, landlord’s tax relief on mortgage interest will be restricted to the basic rate of income tax. These new rules will apply to residential landlords who are subject to income tax on their property income, they will not apply to landlords of commercial property.
The method of calculation of the new interest restriction means that landlords who currently pay tax at the basic rate of 20% may be pushed into the higher rates of 40% or 45%.
This can best be explained by the example aside, which compares the tax position under the old rules in 2016/17 with the tax position in 2020/2021 when the new restriction is fully in place.
The example demonstrates how the lack of ability to deduct mortgage interest from rental profits can force landlords into higher rate tax brackets when there has been no actual change in their circumstances.
The new rules are being phased in over 4 years as follows. In 2017/18 75% of the interest cost can be deducted from profits with basic rate relief for the 25% balance being given under the new rules as above. In 2018/19 the split will be 50/50 and so on until 2020/21 when none of the interest is deducted from profits and basic rate relief is given for all the interest, as detailed in the example above.
What can be done to lessen the impact?
Although the phasing in of the restriction has started, the suggestions we made in November 2015 may still be worth considering;
- If this is applicable to your circumstances, consider borrowing more against any commercial property you may own.
- If you have a trading company that owes you money and cash-flow permits, consider drawing down this money to repay debt on residential property.
- Consider transferring ownership or part ownership of properties to spouses or family members who pay tax at the basic rate. There may be capital gains tax implications so advice would be needed. Permission of the mortgage lender will also be required.
- Make pension contributions to increase the basic rate tax band available (although there are limits on the amount of pension contributions that can be paid).
- Consider whether it is worthwhile incurring additional expenditure, for example repairs, to reduce higher rate tax liabilities.
- Ensure that every possible tax deductible expense is being claimed.
- Make sure that existing mortgages are at the best possible rate
If you have a substantial property portfolio you may wish to consider the following:
- Transferring the portfolio to a limited company, as companies are not caught by the new rules. However advice should be sought because this may trigger capital gains tax liabilities and Stamp Duty Land Tax. In addition, mortgage lenders would have to be informed of the transfer and this may lead to revised mortgage terms and potential additional charges.
- Using a management company to administer the property portfolio. The charges from the management company should be tax deductible against personal rental profits. However care would need to be taken regarding the set-up and operation of the company and there will be company running costs to consider which may negate any tax benefit.
Come what may, our advice to landlords is to consider the impact the changes are having to their tax position and to seek our advice if they would like to explore any of the above suggestions in any more detail.
If no alternative suggestions are thought to be appropriate or realistic, landlords should make sure they have sufficient funds available to pay any additional tax liabilities that may arise. We can provide assistance in estimating these additional tax liabilities.
Please speak to your normal DSG contact if you require any further advice or assistance.