The government have used their 2017 Autumn Budget announcement to gradually decrease the benefits for landlords.
They recently introduced the details of the reduction in tax relief for landlords, which is to affect from 6th April 18 progressively till April 2020. However this is not a tax change, it is actually known as Section 24 which is change in the Generally Accepted Accounting Practice (GAAP).
The UK GAAP, is the overall body of regulation establishing how company accounts must be prepared in the United Kingdom. This includes not only accounting standards, but also UK company law. GAAP is a statutory term in the UK Taxes Acts.
The change basically says that the major component of your expenditure on property letting, your finance costs (namely your interest on your mortgage), will be disallowed from tax calculations.
Before April 2017, before the changes, you were able to deduct your mortgage interest rate cost in your tax return along with all your other costs in your business.
I am going to give you a couple of example workings using the sample numbers below:
1) £12,000 rental income
2) £5,000 mortgage interest costs
3) £1,000 other costs
• = £6,000 profit (1 minus 2 minus 3)
As a Basic rate taxpayer @ 20% = £1,200
As a Higher rate taxpayer @ 40%= £2,400
So a £12,000 rental income would be reasonable for a Buy to Let property. The mortgage costs are £5,000. Other associated costs can include using a great letting agent or maintenance costs. We then simply subtract the costs from the income and we
have a profit of £6,000, this income will subsequently be reduced by the tax due, based on the tax bracket you fall into as above.
When the final stages of the tax relief have been implemented by 6th April 2020 this is no longer the case, as you will no longer be able to offset your financial costs against your tax. The only offset against this total loss of mortgage deduction comes in light of an allowance agreed by the government. You will be allowed a 20% allocation after your profit is calculated.
Here’s an example, using the figures from above, to help show the implications of the changes to your landlord profitability.
• £12,000 rental income
• £1,000 other costs
• = £11,000 profit (On Paper)
• £5,000 Finance (Mortgage) cost not deducted at this point
We now have £11,000 profit which at 20% (basic rate taxpayer) is equal to £2,200 tax and now we know that we are allowed a 20% allowance of finance costs which we can deduct after the tax has been calculated.
Hence the 20% of our finance costs in this example is £1,000 (as our finance costs were
£5,000), take the £2,200 tax we minus the 20% allocation of pounds which gives us
the £1,200 tax to pay.
So if you are a 20% tax payer then you are paying the same as you were pre April 2020.
So the scenario where you are a 40% taxpayer is as follow:
We take our £11,000 profit which is equal to £4,400 in tax; we take the 20% finance interest costs allowance which we are able to deduct.
20% of £5,000 equals £1,000.
£4,400 minus the £1,000 allowance gives us £3,400 total tax to pay.
Therefore as you can see from the simple examples above, the high rate tax payer is the one to suffer from the government changes in the tax relief.
Here is the table of the changes from 2017 to 2020 showing the reductions.
|Tax year||Percentage of finance costs deductible from rental income||Percentage of basic rate tax reduction|
|2017 to 2018||75%||25%|
|2018 to 2019||50%||50%|
|2019 to 2020||25%||75%|
|2020 to 2021||0%||100%|
The changes will inevitably result in fewer landlord purchases and more landlord sales of existing buy-to-lets. Therefore unless enough tenants are persuaded, and enabled, to buy their home by the new initiatives to encourage home ownership, the likely reduction in properties available could potentially push-up rental payable amounts.
Other small changes to buy-to-let include the removal of the annual 10% buy-to-let ‘wear and tear’ allowance. From April 2016 this will be replaced by a system that only allows landlords to claim tax relief when they actually replace furnishings in the rental property. In addition, from April 2019, any Capital Gains Tax (CGT) due on the sale of a residential property will need to be paid within one month of completion; currently it is due at the end of the tax year.
The effect from the above changes has seen an increase in the number of landlords creating limited companies to hold their properties in. There are pro’s and con’s to going down this route, much of which we can discuss, so feel free to discuss how to do this, the implications and the next steps which I can assist with.