Following the chancellor’s announcement in the Summer Budget 2015 there are going to be changes to the tax reliefs that landlords receive. But dependant on the rate of tax you pay, this might not affect you. For example, a basic rate tax payer may not be affected at all.
Currently, as a landlord, you can claim full tax relief on your mortgage interest payments from your rental income before paying income tax. In simple terms, you can offset the cost of your mortgage interest from your rental income when calculating your profits. As an example, if your rental income is £10,000 and you pay mortgage interest of £4,000, your profit is £6,000.
The amount of tax you pay on your profits is decided by your tax band for that year. A basic-rate tax payer pays 20% (£1,200), a higher-rate tax payer pays 40% (£2,400) and an additional-rate tax payer would pay 45% (£2,700).
From 6th April 2017, new changes mean that over the next 3 years a new system will be introduced where you will no longer be able to deduct your mortgage interest payments from your rental income. Instead, the total rental income will be added to your other income (PAYE or self-employed earnings) and you will pay income tax on the overall figure. However, you will then receive a basic-rate tax deduction of 20% on your rental income.
Let’s go back to the previous example and assume you are a basic rate tax payer. Once the changes have in phased in you will now have to pay 20% tax on the full £10,000, so £2,000 (an increase of £800). However, you will then receive your 20% basic-rate tax relief on your mortgage interest of £4,000 (a deduction of £800). Therefore, the total tax due is £1,200, exactly the same as before.
Please be aware that once the changes have been made your taxable income is now being calculated without deducting mortgage interest, which may result in your tax band changing.
If you are a higher-rate tax payer you would only receive a reduction based on the 20% basic-rate. Staying with the same example, you will pay 40% tax on the full rental amount of £10,000, so £4,000. You will then receive your 20% basic-rate tax relief on your mortgage interest of £4,000 (a deduction of £800). Therefore, the total tax due is £3,200, an increase of £800.
Please use this calculator to see exactly how the tax relief changes will affect you.
The changes are being phased in slowly over the next 3 years, with the changes being in full effect on 6th April 2020. The table below details how the changes are being introduced:
|Tax year||Percentage of mortgage interest deductible from rental income||Percentage of basic rate tax reduction received|
|2017 to 2018||75%||25%|
|2018 to 2019||50%||50%|
|2019 to 2020||25%||75%|
|2020 to 2021||0%||100%|
For more information please visit https://www.gov.uk/government/news/changes-to-tax-relief-for-residential-landlords
The information in this post is based on my understanding of the upcoming changes in tax legislation and should not be taken as tax advice. For advice you should consult with a qualified accountant/tax adviser.