In the July 2015 budget the Government announced proposals to restrict the income tax relief available for interest cost for Buy to Let landlords. So what are the new changes to rental tax profits? The new measures – which have been gradually introduced since 6th April 2017 – are aimed at restricting relief on finance cost on residential properties. These changes will affect individual landlords, partnerships and limited liability partnerships who will no longer be able to claim finance costs as a deduction from rental income to calculate the taxable rental profit. It will be replaced from the individual’s/partner’s income tax liability.
The changes mean that landlords will no longer be able to deduct all of their mortgage interest costs for their property portfolio in order to arrive at the base figure for their company profits. All income will now be lumped together and tax on everything will be subject at least to the basic rate of income tax.
The actual, progressive rules mean that landlords will be able to obtain relief as follows:
- in 2017 to 2018 the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction
- in 2018 to 2019, 50% finance costs deduction and 50% given as a basic rate tax reduction
- in 2019 to 2020, 25% finance costs deduction and 75% given as a basic rate tax reduction
- from 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction.
The Government also announced measures which affect the 10% wear and tear allowance which was available based on the gross rental income. Moving forwards, only the actual expense will be allowed to be offset against the rental income. Companies will not be affected by these new rules.
Key impact of these changes:
- These changes will give rise to higher Income Tax liabilities for landlords due to the reduction in allowable expenditure resulting in an increase in total income
- Basic rate tax payers may now fall into higher rates of tax as they will be taxed on turnover as opposed to profits
Lets look at a worked example to assess the impact of these changes in 2020/21 versus pre-section 24 rules*:
A landlord has one BTL property worth £400,000 where his income is from rental is £18,000. She has actual expenditure cost of £1,500 and mortgage finance cost of £9,000. She also is in full time work and has a salary of £48,000.
|Pre Section 24 rules||New rules – 2020/21|
|Expenditure||-£ 1,500.00||Expenditure||-£ 1,500.00|
|Finance Cost||-£ 9,000.00||Taxable profit||£ 16,500.00|
|Taxable profit||£ 7,500.00|
|£16,500 @ 40%||£ 6,600.00|
|Tax due on rental profit||£ 3,000.00|
|£7,500 @ 40%||Less: basic rate reduction||-£ 1,800.00|
|Tax due on rental profit||£ 4,800.00|
|Cash Position||£ 7,500.00||Cash Position||£ 7,500.00|
|Tax payable||£ 3,000.00||Tax payable||£ 4,800.00|
|Net Cash||£ 4,500.00||Net cash||£ 2,700.00|
*Worked example does not constitute tax advice and is just for illustrative purposes only.
What options are available to minimise the impact of the Section 24 rules?
Many landlords are now considering incorporating their business into a limited company to avoid being caught up by the new rules. There are benefits and drawbacks to setting up a limited company for purchasing rental properties with the main one being the mortgage availability for limited company buy to lets. If you would like to weigh up the options and explore mortgage availability why not speak with Visionary Finance who are independent and whole of market mortgage advisers specialising in buy-to-let mortgage advice. Our free and expert advice will certainly benefit landlords looking to continue to grow their property portfolio.
If you have any queries about the borrowing or lending process, please call our office on 01908 465100.