Reducing landlords tax relief on mortgage interest – the impact is greater than you might think!

As a landlord, we would be surprised if you haven’t read something in the news about the tax relief restrictions in respect of mortgage interest.

However, you may have also read that this only applies to higher rate taxpayers and perhaps knowing that your total taxable income is say below £40,000 (the higher rate threshold for 2017/18 is £45,000) you dismissed the article and moved on. Who wants to read about tax news anyway apart from accountants?

Let’s say the £40,000 you ‘earn’ is £30,000 from your job and £10,000 rental profit after expenses. However, if you are in the position (like many landlords are), whereby the borrowings costs are a significant chunk of your rental income, then the £10,000 profit might be made up of rental income of say £30,000 less mortgage interest of say £20,000.

Assuming that you are aware of the changes and ignoring the tapered introduction of the tax relief measures, we will compare the positions in the tax year pre the introduction of these measures (2016/17) and the tax year post the measures when they are fully enacted (2020/21). (Tax rates and allowances are assumed to remain static between 2016/17 and 2020/21 for illustrative purposes only).

 

2016/17

2016/17

2020/21

2020/21

Employment income

 

30,000

 

30,000

Rental income

 

30,000

 

30,000

Less: mortgage interest

 

(20,000)

 

(-)

Total income

 

40,000

 

60,000

Less: personal allowance

 

(11,000)

 

(11,000)

Taxable income

 

29,000

 

49,000

 

 

 

 

 

Basic rate tax charged

29,000 x 20%

5,800

32,000 x 20%

6,400

Higher rate tax charged

0 x 40%

0

17,000 x 40%

6,800

 

 

 

 

 

Less: Basic rate relief - interest

n/a

(0)

(20,000) x 20%

(4,000)

 

 

 

 

 

Tax liability

 

5,800

 

9,200

 

As you can see, there is nearly a 59% increase in the tax liability between 2016/17 and 2020/21 with no change in circumstances.
 
Not only does the tax significantly increase directly due to the rental income but other issues may arise such as:
 
  1. Child benefit could be repayable to HMRC – this starts to become repayable if income exceeds £50,000 and fully repayable when income exceeds £60,000 – you may not be affected in 2016/17 as your total income is £40,000 but in 2020/21, your total income would be £60,000 meaning that all child benefit received by you or someone you live with, must be paid back to HMRC.
  2. Personal allowance may be restricted – this starts to be withdrawn once total income exceeds £100,000. If your employment income was £90,000, then in 2016/17, total income would not exceed £100,000 so you would be able to claim the full £11,000 personal allowance. However, in 2020/21, you would lose most of your personal allowance as your income would be £120,000, which means that your personal allowance would reduce to £1,000. This would have the effect of increasing your tax bill by a further £4,000.
  3. Pensions tax relief is restricted – currently high earners are limited on the amount that they (and their employer) can save towards a pension once their income (plus the total of the pension contributions) goes above £150,000. Removing the mortgage interest relief as a deduction from total income, simply makes things worse for high earning landlords with pensions, by reducing the amount that they can save for a pension.
  4. 30 hours free childcare / tax free childcare – your eligibility to claim either of these is on the basis that you earn less than £100,000. The income used to assess your claim will increase as a result of the measures which means you may not qualify for either of these benefits.
  5. Tax credits could be restricted - perhaps you are at the other end of the spectrum and you have a low employment income and are claiming tax credits. The income used to assess your tax credits claim could increase which is likely to decrease your tax credits.
  6. The amount of bank interest that you are able to receive free of tax may decrease.
  7. Student loans – the amounts repayable may increase.
  8. Capital gains tax (CGT) – a higher rate of CGT may be payable on any sales of properties, shares etc as a result of the increase in total income.
 
Planning opportunities
 
So, faced with the above pitfalls, what can be done? 
 
You could look to minimise the tax bill by:
 
  1. Incorporating the rental portfolio into a company as companies are not affected by the new changes. However, you would need to consider stamp duty and capital gains tax on any transfer in addition to any requirements of the mortgage lender.
  2. If the properties are run as a business, rather than a passive investment, then the interest relief may be available in full. However, HM Revenue & Customs usually take a lot of convincing that a property portfolio is a business and there is the added cost of self employed national insurance to consider.
  3. Increase rents – possibly an unpopular move with any tenants, which will also increase the tax bill but for every £100 increase, the landlord would have say £60 after tax which may help set off some of the additional tax due as a result of the decrease in allowable interest costs.
  4. Sell the property – possibly a drastic move and CGT needs to be considered as well as the investment of any proceeds.
  5. Ensure that all of the allowable expenses are claimed to reduce tax – a simple point but this can be overlooked by landlords.
  6. Make use of any availability of spouse’s allowances and capacity for income to be taxed in lower tax brackets. However, Stamp Duty Land Tax needs to be considered.
  7. Consider ways to reduce the higher rate tax payable on the profit – pension contributions and gift aid donations being two of the main ways.
  8. Consider changing the property to a holiday property – if at all possible – as they are not affected by rules outlined here. There are important steps to be followed and advice is critical.

They key is to take a proactive approach and obtain some professional advice about your situation. There may be other options, not listed above, depending upon your personal circumstances.  

Our tax teams are here to help by giving tailored advice to your own circumstances – call Lee Watson at Darlington on 01325 349700, Nicola Bellerby at Durham on 0191 3842244 or Rosemary Anderson at York on 01904 784400.