Mortgage interest tax relief changes: A landlord's guide

Mortgage interest tax relief changes: A landlord's guide

Find out more about the recent changes to the mortgage tax relief rate that were announced in the 2015 budget, and what it means to you as a landlord with Direct Line for Business.


What were the mortgage interest relief changes in the 2015 Budget?

Chancellor George Osborne decided to withdraw higher rate tax relief on mortgage and finance interest for higher rate taxpayers. This means buy-to-let and house in multiple occupation (HMO) owners are effectively restricted to claim the basic level of income tax. 

For the 2015-16 tax year, the basic level of income tax is 20% and the higher rate is 40%. Once the changes come in, anyone buying to let will only have the option of 20% tax relief. Anyone benefiting from the higher rate and saving money on tax (via 40% figure) will no longer be able to do so. The basic rate figure will be a flat rate for all buy to let and HMOs landlords.

Holiday lets, second homes, companies renting out homes and business property are unaffected by the change.

Although the tax changes mainly involve mortgage interest, the legislation also touches on ‘finance interest’, which includes overdrafts, credit cards and fees charged by mortgage brokers.

The measure also alters the way property business profits are calculated, which could bring more basic rate taxpayers into the higher rate tax net.

Who is affected by the Budget 2015 changes?

The mortgage interest relief measure is specifically aimed at higher and additional rate buy-to-let and HMO landlords.

The government says the policy objective is to stop wealthy landlords unfairly benefiting from the most generous tax treatment.

To give landlords time to review their business finances, the changes don’t take effect until 6 April, 2017, and even then are phased in over four years.

Buy to let changes? What this means for landlords

The government says landlords paying at the basic rate should see no change in the amount of tax they pay. Other landlords will pay an extra £1.3 billion by April 2021.

Treasury figures estimate the measure will affect one in five landlords.

Can I claim tax relief on mortgage interest?

Yes, landlords can continue to claim mortgage interest relief as a property business expense, but how this is done changes.

Until April 2017, the rules allow all landlords to claim relief on property business finance payments at their marginal rate. Landlords claim this the same way as other business expenses are claimed.

The marginal rate is the highest rate of tax they pay, which can be 20%, 40% or 45%.

Taxable profits are calculated by taking total rents for the tax year and subtracting total business expenses. House or portfolio values are not relevant for the calculation. The key figure is the amount of rent due in the tax year.

Here’s an example of basic rate tax payer.

  • A basic rate taxpayer (20%) has a salary of £40,000 and rental income of £15,000. They then have mortgage interest payments of £8,500 and other expenses of £2,000, for a total of £10,500.

This landlord’s taxable profit is £15,000 minus £10,500, which is £4,500.

Tax on £4,500 at 20% is £900.

Under the new rules, these figures will change to the below.

  • Our basic rate taxpayer’s rental profits will become £15,000 minus £2,000 expenses, which is £13,000.

Tax is charged on £13,000 at 20%, which is £2,600, then a mortgage interest tax credit of £8,500 at 20% is deducted.

The mortgage interest credit is £1,700, reducing the tax due to £900 – the same as the current calculation.

Here’s an example of a higher rate tax payer.

  • A higher rate taxpayer (40%) has £60,000 a year rental income. The mortgage interest payments are £20,000 and other expenses total £12,000.

This landlord’s taxable profit is £60,000 minus £32,000, which is £28,000.

Tax on £28,000 at 40% is £11,200.

The new rules mean these figures will change.

  • Our higher rate taxpayer sees a difference in the tax they pay:

The taxable profit is £48,000 (£60,000 minus £12,000) after deducting expenses. This means the tax bill is £19,200, minus the mortgage interest relief credit of £4,000 (20% of £20,000 = £4,000).

This means the new rules would increase the final figure by £4,000 to £15,200.

What are my options as a landlord?

Practical tax planning varies for each landlord. The worst hit by the changes will have high borrowings and pay tax at the highest rates.

Some tax experts are suggesting landlords should transfer their properties to limited liability partnerships (LLP) or companies as they are unaffected by the changes.

In most cases, if a trader decides to turn this business into a corporation, any existing business assets are transferred with incorporation relief. This would cancel out any capital gains tax.

However, buy to let does not count as a business, so incorporation relief does not apply. Capital gains tax is paid on the value of these properties too and the LLP or company would also have to pay stamp duty plus 3% on the transfer.

The cheapest and easiest option is income shifting to a spouse who pays tax at the basic rate. The Chancellor has hinted the personal allowance should hit £50,000 by 2020, which gives a lot of scope to move a share in a property business to a partner paying tax at a lower rate.

Consider buying any new properties as an LLP or company. Bear in mind though that the Chancellor may shut the door on this loophole at any time.

How have landlords taken the news?

Some landlords are campaigning against the changes. They’ve launched a judicial review in the High Court on the grounds the new measure breaches their human rights as other businesses don’t have their finance interest tax relief restricted.

A Parliamentary petition would suggest many landlords either accept the tax change or are not worried about the financial consequences. The petition raised 60,893 signatures. But this is nearly 40,000 short of the number needed to trigger a debate in Parliament.

Considering England and Wales has an estimated 4 million buy-to-let and HMO homes the petition response was hardly overwhelming.

The government did publish a written response to the campaign: “Landlords are currently able to offset their mortgage interest and other finance costs against their property income, reducing their tax liability.

“This relief is not available for ordinary homebuyers and not available to those investing in other assets such as shares. Currently the landlords with the largest incomes benefit the most, receiving relief at their marginal tax rates of 40% or 45%.

“By restricting finance cost relief available to the basic rate of income tax (20%) all finance costs incurred by individual landlords will be treated the same by the tax system. This recognises the benefits to the economy that investment in property can bring but ensures the landlords with the largest incomes will no longer benefit from higher rates of tax relief.

“By unifying the treatment of finance costs for all individual landlords, the government is reducing the distortion between property investment and investment in other assets, and reducing the advantage landlords may have in the property market over ordinary homebuyers.”

Summary

Restricting mortgage interest tax relief and altering how taxable property business profits are calculated are undoubtedly going to affect huge numbers of landlords.

The issue to bear in mind is that all the current calculations are based on the income tax personal allowance remaining static until 2020. That year is when the government has indicated they would like to raise the figure from £11,000 in 2016-17 to £50,000 by 2020.

If they do, this will have a significant impact on the extent of the tax changes as fewer higher rate taxpayers will be dragged into the tax net.

Landlord Insurance Steve Sims
Steve Sims

Steve Sims
Last Updated: 27 Jun 2016