Stripping Buy-to-Let Landlords of Mortgage Interest Tax Relief Deemed “Disastrous” by Experts

In the summer of 2015, the chancellor at the time, George Osborne announced the decision to cut mortgage interest tax relief for buy-to-let landlords. This was – and still is- deemed disastrous to the sector by property experts who believe the tenants will bear the brunt.

Before the tax relief was removed

Prior to the law, rental property-owners were entitled to tax relief on payments for the mortgage interests. Simply put, they could offset the expenses of the mortgage interest from their rental income when calculating their profits. So, if a landlord receives a rental income of £9,500 per annum, but pays a mortgage interest of £7,000, the profit earned is the difference between both amounts, £2,500.

Landlords normally pay an income tax on profits earned, based on their income tax band. In this scenario, the basic-rate taxpayer would pay 20% tax on £2,500 or £500 and keep £2,000. A 40% tax payer would pay £1000 and keep £1000, while a 45% taxpayer would keep £1,375 after paying a tax of £1,125.

Reduction of the relief

Now that the tax relief has been reduced, starting April 2017, gradual changes will be phased in till April 2020. George Osborne, in his announcement stated that landlords would be unable to deduct all their mortgage expenses (including interests) when they calculate their profits.

Contrary to the previous structure, mortgage interest tax relief will be reduced gradually to 20% over a period of three years beginning from April 2017. So a landlord of £9,500 annual rental income with £7,000 mortgage interest will be paying tax on the whole amount, less a credit of 20% on the mortgage interest.

Thus, a higher rate taxpayer’s bill 40% of £9,500 will be £3,800, less 20% of £7,000 which is £1,400. That amounts to a total of £2,400 which is £1,400 more than before. This whopping increase is bound to be felt across tax brackets, more so among higher tax payers.

The effects on profits

Higher rate tax-payers will experience a nullification of their returns if the mortgage interest is 75% or higher than their rental income. The limit for additional-rate taxpayers occurs when mortgage interest becomes 68% of rental income. The basic-rate taxpayer, however, experiences no changes to his or her tax liability. But the new calculation system for profits could bump a basic rate tax payer into a higher tax bracket.

Why experts believe it could be disastrous

Due to increasing mortgage rate expenses and the reduced tax relief, property experts believe the only way most landlords will seek to recoup their expenses is to shift costs to their tenants. This means there could be higher rents and deposits for many renters. Already, some speculators have asked people to brace themselves for a 25% increase in rent in coming years.

How to avoid the tax changes

Businesses registered as a limited company are not affected by the tax relief changes to the mortgage interests. It would be smart for landlords to consider registering their property business as a limited company. However, it is necessary to note that HRMC will regard any transfer of property ownership as a sale, so be mindful of capital gain taxes to be paid.