Buy-to-let changes: Tax adviser breaks down the impact on clients

by: Alex Wavell, chartered tax adviser at Moore Blatch
  • 15/03/2018
  • 0
Buy-to-let changes: Tax adviser breaks down the impact on clients
Tax changes are starting to hit landlords and this is prompting some to move their portfolios into limited company arrangements. Chartered tax adviser Alex Wavell explains how the changes work and examines what the results might be.

 

Before 6 April 2017, for every £1 that a landlord spent on finance costs in relation to a rented property, mortgage interest being the most common, they had £1 less of rental income being subject to tax.

This did not just mean that tax was saved on that £1 spent, but also that the landlord’s total taxable income was reduced by £1.

This can be important in relation to such things as the loss of personal allowance or savings allowance, or the child benefit charge.

All of these are aligned to the level of a taxpayer’s total taxable income.

 

Financially worse off

The net taxable rental income was previously calculated by taking the gross rental income received and subtracting the tax-deductible expenditure (including finance costs).

This total was then added to a landlord’s other taxable income (for example bank interest or salary) to determine their total taxable income.

However, this is no longer the case, and the consequence is that many landlords will now be financially worse off.

The new rules are currently being phased in, over the course of four tax years, with the current 2017/18 being the first of those tax years.

Net rental income, and therefore total taxable income, will now ultimately be computed without deducting finance costs.

This will immediately lead to a taxpayer having a higher amount of total taxable income when comparing like-for-like.

Instead, up to 20% of the finance costs will be offset against a landlord’s tax liability.

 

How the rules work

The phasing in of the new rules will work as follows:

Tax Year % of finance costs that can continue to be deducted from rental income (old rules) % of finance costs that are taken into account in calculating the tax credit (new rules)
2017/18 75% 25%
2018/19 50% 50%
2019/20 25% 75%
2020/21 (and onwards) 0% 100%

 

Landlords who are higher rate or additional rate taxpayers will be worse off under these new rules. So too will some basic rate taxpayers.

The actual deductible tax credit each tax year will be 20% multiplied by the lower of:

  1. The finance costs of the tax year (those that fall within the end column above);
  2. The net taxable rental profit of the tax year (less any prior year losses);
  3. The total taxable income of the tax year (excluding interest and dividend income), after personal allowance has been deducted (where available).

In the event that (1) does not produce the lowest figure, this will mean that not all the finance costs incurred would even be attracting 20% tax relief. Fortunately, any ‘unused’ finance costs can at least be carried forward and treated as finance costs of future tax years.

 

Working examples

The rules are best explained with illustrations, so here are two.

They are both based on a personal allowance of £11,500, a basic rate band of £33,500, a savings allowance of £1,000 (basic rate taxpayers) or £500 (higher rate taxpayers) and identical income throughout, for 2016/17, 2017/18 and 2018/19.

 

Illustration 1:

Andy receives rental income of £60,000. His rental expenses are mortgage interest of £15,000 and management fees of £5,000. His only other income is £600 of bank interest.

 

  2016/17 tax position 2017/18 tax position 2018/19 tax position
Gross rental income £60,000 £60,000 £60,000
Less mortgage interest (£15,000) (£11,250) (£7,500)
Less management fees (£5,000) (£5,000) (£5,000)
Taxable rental income £40,000 £43,750 £47,500
Bank interest £600 £600 £600
Less personal allowance (£11,500) (£11,500) (£11,500)
Total taxable income £29,100 £32,850 £36,600
Savings allowance utilised £600 £600 £500
Basic rate tax (20%) £5,700 £6,450 £6,700
Higher rate tax (40%) £1,040
Tax before finance costs £5,700 £6,450 £7,740
Less finance costs (20%) (£750) (£1,500)
Total tax payable £5,700 £5,700 £6,240

 

Andy remains a basic rate taxpayer in 2017/18, despite the introduction of the new rules, so here his position is unchanged compared to 2016/17.

However, in 2018/19 the new rules lead to him becoming a higher rate taxpayer (and a slight loss of savings allowance), and therefore he has a higher amount of tax to pay. This will continue to increase during the remaining two years of the rules being phased in.

 

Illustration 2:

Belinda receives rental income of £60,000. Her rental expenses are mortgage interest of £20,000 and management fees of £5,000. Her only other income is a salary of £35,000.

  2016/17 tax position 2017/18 tax position 2018/19 tax position
Gross rental income £60,000 £60,000 £60,000
Less mortgage interest (£20,000) (£15,000) (£10,000)
Less management fees (£5,000) (£5,000) (£5,000)
Taxable rental income £35,000 £40,000 £45,000
Salary £35,000 £35,000 £35,000
Less personal allowance (£11,500) (£11,500) (£11,500)
Total taxable income £58,500 £63,500 £68,500
Basic rate tax (20%) £6,700 £6,700 £6,700
Higher rate tax (40%) £10,000 £12,000 £14,000
Tax before finance costs £16,700 £18,700 £20,700
Less finance costs (20%) (£1,000) (£2,000)
Total tax payable £16,700 £17,700 £18,700

 

Belinda is a higher rate taxpayer throughout.

Consequently, her tax liability increases as a result of these new rules – this is even without losing any allowances, or becoming an additional rate taxpayer.

This will continue to increase during the remaining two years of the rules being phased in.

While these examples should prove useful, it is important to remember that your clients should get qualified tax advice for their situation.

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