As of the next tax year (2017/18), buy-to-let landlords who sit in the higher-rate or additional-rate tax bands will be hit with higher tax bills. Those who are nearing the limit of the basic-rate tax band are also likely to end up paying more tax.
How does it work at the moment?
Currently, as a buy-to-let landlord you’re allowed to deduct the full amount of allowable expenses (mortgage interest payments often being the biggest) from your profits. You effectively only pay tax on the rental profits.
Allowable expenses for buy-to-let landlords include:
- Mortgage interest relating to the property
- Most repair costs to property
- Interest on loans to buy furnishings
- Fees incurred when taking out or paying back mortgages and loans
The Government has decided to change this, so that by the 2020/21 tax year, you’ll only be able to claim basic-rate tax relief (currently 20%) on your buy-to-let expenses. This move will be staggered over four years.
Will it affect all landlords?
Landlords who remain in the basic-rate tax band after the changes take effect won’t see their tax bills on buy-to-let properties rise. However, you may find the reduction in tax relief pushes you into the higher-rate tax band, which will ultimately mean a higher tax bill.
The new rules also only apply to buy-to-let landlords. If you rent out commercial property or have furnished holiday lettings, you won’t be affected by the changes.
When will the new rules come into effect?
The changes will be brought in gradually over the next four tax years, starting April 2017, as follows:
- In the 2017/18 tax year, tax relief will be split so that you can claim 75% of allowable expenses, and will receive relief at the basic-rate (20%) on the remaining 25%;
- In 2018/19, this will change to a 50/50 split between the two;
- In 2019/20 you will only be able to claim 25% of allowable expenses and will receive 75% of the 20% tax relief on expenses;
- In 2020/21, the switch will be complete, with the only tax relief being the basic-rate of 20% on your allowable expenses.
|Tax Year||Tax relief on allowable expenses||Tax relief at basic-rate on allowable expenses|
Katie is a higher-rate tax payer. She has a buy-to-let property that generates £25,000 in rental income over the tax year. Her allowable expenses (mortgage interest etc.) for this period total £15,000.
Under the current system, Katie only pays tax on the profit, which stands at £10,000 (the income of £25,000 minus expenses of £15,000). Being a higher-rate taxpayer, the tax due is 40% of this figure, which is £4,000.
Assuming the income and costs remain the same in the 2020/21 tax year, Katie will have to pay 40% tax on the total income of £25,000, which comes to £10,000. The only reduction on this is basic-rate tax relief (20%) on the expenses of £15,000, which comes to £3,000.
The resulting tax bill is £8,000, which is a 100% increase on what she would pay in the current tax year.
|Allowable expenses (mortgage, etc.)||£15,000||£15,000||£15,000|
|Relief due on expenses||£15,000||£7,500||nil|
|Tax due at 40%||£4,000||£7,000||£10,000|
|Tax relief at basic rate (currently 20%)||nil||£1,500||£3,000|
|Total tax due||£4,000||£5,500||£7,000|
Would I be better off setting up a limited company?
Without knowing your individual circumstances, we can’t advise on whether a limited company structure is best for you. However, if you have more than one property and you don’t need to regularly withdraw the profits generated, it could well be more tax-efficient to run them through a limited company.
For more advice, get in touch with us today.