The second phase of the Government’s mortgage interest tax relief changes for buy-to-let landlords comes into force today. 2017/18 marked the start of the changes linked to the restriction of tax relief on landlords’ finance costs, while 6th April this year sees the second phase of the reduction.
Who do the changes affect?
The restrictions to mortgage interest tax relief apply to all landlords of residential properties falling under the individual, partnerships or trust structures. If you are based in the UK with a buy-to-let property abroad, or live outside of the UK but let a property here, the change also applies to you.
Who won’t be affected?
It’s good news for landlords with properties in a company structure, as the changes do not apply to those investors. Any furnished holiday let owners, development businesses or anyone dealing in land and property will also be exempt.
What the changes mean
Second Phase of Mortgage Interest Tax Relief Changes Comes in Today
The Government’s tax changes are more far-reaching than many people expect, so make sure that you’re not caught unaware. Covering both interest and tax relief, the following finance costs are affected by the restriction:
- Mortgage interest on buy-to-let properties
- Interest on loans for furnishings or general expenses
- Tax relief for the arrangement of loans and any other associated fees
- Any costs linked to alternative finance arrangements
As of 6th April 2018, the percentage of interest that landlords can take off their property-based income will reduce from 75% to 50%. This means that the amount of tax that you will pay at both the basic and higher rate will be less, but the overall amount of tax you will pay is likely to increase.
This may sound contradictory, which is because the remaining 50% will only be eligible for basic rate tax relief and could push you into the higher Income Tax bracket.
How to work out tax relief
To clarify, only 50% of interest can be taken off your rental income. Of the remaining pot, the basic rate of 20% can be claimed as a credit against your tax bill.
However, there are certain stipulations on this credit amount, meaning that, if the credit amount is more than (a) the tax on your rental income, or (b) your savings income, including dividends, the credit would be capped at whichever is the lowest of these two amounts. But do remember that the excess can be carried forward and can be used in a later year if needed.
The solution
Unfortunately, there is no easy way to avoid the tax changes, but one option would be to change your lettings business into a company structure. The advantage of this would be that, not only could you avoid finance cost restrictions, but you could also shield at least some of your rental profits from Income Tax of up to 45%.
You would, however, need to foot the bill for Corporation Tax, but, at the current rate of 19%, this is much more friendly on the purse strings. If you do go down this route, it’s important to remember that it could lead to other tax charges, so do take professional finance advice.
Another way to avoid the tax changes would be to reduce the interest you are paying out, for example, by accessing any savings you have to lessen the amount that is borrowed. The savings over time, based on paying less interest, will certainly be more than what the money would make in a savings account. If this isn’t an option for you, an offset mortgage could be another answer.
Although the second phase of the mortgage interest tax relief changes could cause some problems for you, try to see this as a good opportunity to refine and take stock of your lettings business, before the changes are fully implemented in 2020. This could help to lessen the financial impact of this round of the changes.