Hard hitting changes to the way landlords account for mortgage interest will be phased in over a period of four years from April 2017. It is estimated that 20% of landlords will pay more tax once this measure is fully implemented and many have warned that landlords will seek to recoup the costs by hiking up rents.
Higher rate tax relief on landlords’ finance costs - mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans - will be gradually withdrawn. Currently, landlords who are individuals/sole traders or partnerships can deduct all of their finance costs from their rental income before tax is levied on the balance. This means that landlords are given relief at their respective marginal rate of income tax, be that 20%, 40% or 45%.
Landlords will no longer be able to treat the interest as a deduction in the computation of net property income but will instead claim a basic rate relief as a deduction from their tax liability. This restriction will not apply to properties that qualify as furnished holiday lettings.
Under current rules, landlords are able to deduct 100% of mortgage interest paid from the property income (i.e. rents). Commencing April 2017, over the four tax years that follow, the deductions of interest permitted from profits will be:
75% for 2017/18
50% for 2018/19
25% for 2019/20 and
For each of those tax years, the percentage of interest not deducted (25%, 50% and 75%) will be given as a basic rate tax deduction, to be calculated as 20% of the lesser of:
the finance interest not deducted from rental profits
the profits of the property business in the relevant tax year or
the individual’s total income (excluding savings and dividend income) that exceeds the personal allowance and, where applicable, the blind person’s allowance for the relevant tax year.
Insofar as the tax reduction is limited by reference to the profits of the property business, unrelieved interest may be carried forward to future tax years.
The government predicts that this measure will raise an additional £665m and that 20% of landlords will pay more tax. This will significantly affect the income a landlord generates and many predict that landlords will be forced to increase rents for tenants and/or spend less maintaining their properties.
Sole traders and those operating their business through a partnership may wish to consider transferring their properties to a corporate structure or purchase further properties through a company. There are, as ever, other tax considerations associated with this course of action, including Stamp Duty Land Tax, but the announcement of a further reduction in corporation tax to 19% in 2017 and 18% by 2020, coupled with the ability to deduct all finance costs to arrive at the company’s taxable profits, it is a far from unattractive option. Any landlord thinking about incorporating their businesses should seek specialist advice on the pros and cons of incorporating.
As an aside, landlords who let a room in their only or main residence can benefit from an increase in the government’s rent a room scheme. From 6 April 2016 the amount which can be received tax-free from a lodger is increased from £4,250 to £7,500.