Budget 2015 - Tax changes for private landlords
In an unexpected announcement in the 2015 Budget, a valuable tax relief available for private landlords has been severely restricted.
The cost of a landlord's finance (e.g. the interest payments made on mortgages), in common with other types of business, is currently a valid deductible expense, meaning that the private landlord only pays tax on his or her actual profits. From the 2017-18 tax year onwards this will gradually be changed, which is likely to increase the amount of Income Tax due. For many landlords this change could make their business unprofitable.
Mary is retired, with a pension income of £25,000 per year. She has a Buy to Let portfolio which generates £80,000 in rent per year. Her mortgage interest costs are £60,000 and her other costs are £5,000 per year.
According to the current rules, Mary would be liable for Income Tax on her £25,000 pension income and her £15,000 rental profits, taxed at the marginal rate of 20%. Her business is profitable, and she only pays tax on the £40,000 she makes, which amounts to £5,800 Income Tax and an overall Income Tax rate of 14.5%.
Once the above changes are fully implemented, Mary would be taxed on her pension income plus her total rent (minus non-interest expenses), which amounts to £100,000 overall. Her gross tax liability would be £29,200 but subject to relief for her mortgage at a rate of 20% (£12,000). Overall she would pay £17,200 Income Tax, at a marginal rate of 40%, which is an overall Income Tax rate of 43%.
NOTE: This case study assumes that tax rates, bands and allowances remain at the announced 2016-17 levels.
Who will this effect? This change will affect all private landlords who hold mortgages or other loans and whose total rent and other income (before mortgage or other interest is deducted) exceeds the 40% Income Tax threshold. This means that the change could impact basic rate (20%) Income Tax paying landlords, if they hold large mortgages. The restriction will disallow interest as a deduction from gross income, instead reducing the amount of Income Tax due. Overall, many taxpayers will be significantly worse off. See the case study above for how it would work in practice.
When does this change come into force? The measure will take effect for all finance costs incurred on or after 6 April 2017, and there is no indication of any grandfathering of loans taken out before this date.
The change will be phased in over four years, starting in the 2017-18 tax year, when 25% of finance costs will be subject to the new rules, growing to 50% in the 2018-19 tax year, 75% in 2019-20 and from the 2020 tax year onwards these rules will apply to all finance costs.
Holders of rental property portfolios, with high levels of borrowing may struggle to generate a net income profit once this change to income tax takes effect. When interest rates eventually rise, this will exacerbate the problem, with many landlords forced to sell up, or transfer their business into a limited company.
If you or your clients are affected by this change, and would like to discuss any aspects of the capital taxation of rental property and potential solutions, please contact Paul Colman or any member of the Wrigleys' Private Client team on 0113 244 6100.
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The information in this article is necessarily of a general nature. Specific advice should be sought for specific situations. If you have any queries or need any legal advice please feel free to contact Wrigleys Solicitors.