Buy-to-Let tax changes

At the moment, landlords can claim tax relief on their mortgage interest payments at their marginal rate of tax. However, under new plans introduced by former chancellor George Osborne in his 2015 summer Budget, tax relief will be cut to a marginal rate of 20 per cent and landlords will have to pay tax on their rental income before costs (mortgage interest) have been subtracted.

The new system is being phased in from 2017. By 2020, when the rules are fully in place, some landlords will face dire consequences.

Case study

A landlord has a loan of £150,000 at 5 per cent and brings in £1,000 a month in rent. Annual income is £12,000, of which £7,500 is spent on mortgage payments and £4,500 is profit.

Under the current rules, since the mortgage cost attracts full tax relief, 40 per cent income tax only applies to the £4,500 profit – an income tax bill of £1,800. After tax, that leaves the landlord with £2,700 net profit for the year.

Under the new rules, in 2020, the entire £12,000 income will be taxable, but there’s relief of up to 20 per cent for the mortgage.

So there’s a full liability of 40 per cent on £12,000 (£4,800), but the landlord can claim 20 per cent relief on the £7,500 spent on the mortgage (£1,500), cutting the tax bill to £3,300. So from that £4,500 profit the landlord now gets just £1,200 after tax.

The fact that the full income is taxable means people may be pushed into a higher tax band. Under the current rules, only the profit is considered for tax purposes.

So a basic-rate taxpayer earning a £35,000 salary plus that £4,500 of profit would have £39,500 of taxable income. With the new rules, that landlord with a £35,000 salary would also have the full £12,000 of rental income counted: a total taxable income of £47,000, which would push them into the higher-rate tax band.

Post Courtesy of Money Observer.