HMRC has now filled in the gaps on how mortgage finance relief will apply to buy to let landlords from April 2017.
The new rules change the way property rental profits are calculated by taking away tax relief on mortgage and other interest payments.
Instead, a flat rate tax relief of 20% for mortgage and finance interest will be phased in over four years.
So, if a landlord collects rental income of £10,000 a year, but pays mortgage interest of £9,000, the profit is the difference between the two, or £1,000.
Currently, landlords pay tax on their profits according to their income tax band. So, in this simplified example, a basic-rate taxpayer would pay 20% tax on £1,000, or £200, and keep £800. The tax bill for a 40% taxpayer would be £400, leaving £600, or £450 for a taxpayer at the 45% additional rate, leaving £550.
Once the new flat rate tax relief is introduced, our landlord with rental income of £10,000 and £9,000 of mortgage interest will have to pay tax on the full amount, less a 20% credit on the mortgage interest. The tax bill for a higher rate taxpayer would therefore work out at £4,000 (40% of £10,000 profit) minus £1,800 (20% of £9,000 interest), which equals £2,200, up from £400 under the current tax regime.
The measure affects both buy to let landlords paying tax in Britain and renting homes in the UK, and overseas and expat or foreign landlords letting homes in the UK from abroad.
Property companies, commercial landlords and holiday let businesses are unaffected. Besides mortgage interest, finance interest on loans, overdrafts and some other linked charges are also impacted.
Landlords who have mixed commercial and residential portfolios will have to work out a fair and reasonable way to split the loan interest between the different categories of property.
“Finance costs won’t be taken into account to work out taxable property profits. Instead, once the income tax on property profits and any other income sources has been assessed, any income tax liability will be reduced by a basic rate tax reduction. For most landlords, this’ll be the basic rate value of the finance costs,” says the new HM Revenue and Customs (HMRC) guidance.
If you are a higher-rate taxpayer, the new tax will wipe out your returns if your mortgage interest is 75% or more of your rental income. The tax liability of a basic-rate taxpayer is unchanged, however, the new profit calculation could push a basic-rate taxpayer into a higher tax band.
The new rules were announced by former Chancellor George Osborne in his 2015 Summer Budget and he described them as levelling up tax breaks between property investors and first time buyers.
At the same time, he scrapped the 10% wear and tear allowance for landlords renting out furnished property and slapped a 3% stamp duty differential on buying homes for investment.