Tax is an increasingly important element of investing and letting property and there are four tax changes taking effect in 2018 that could affect landlords. While some will impact on your profits this tax year, some will have an effect into the future, so it’s important that you understand what the changes are and plan ahead to ensure your investment delivers the returns you expect and you don’t get any nasty surprises when your tax bills arrive.
Mortgage interest relief
This year’s tax return (for the year 2017/18) is the first that will reflect the phased withdrawal of higher-rate tax relief on buy to let mortgage interest. Only 75% of the interest can be deducted from rental income; the remaining 25% will be restricted to tax relief at the basic rate of 20% and will be given as a reduction in tax liability. If you have not yet planned for the full rollout, now is the time to do so, as the proportion of mortgage interest you can deduct from higher-rate taxable income will reduce by 25% each year until it disappears in 2020/21.
The example below illustrates the difference between the profit a landlord in a 40% tax-paying position would have realised in 2016/17 versus three years’ time when all mortgage interest can only be claimed as a reduction in liability at the basic-rate:
|Other allowable costs||£2,000|
|Pre-tax profit (A)||£5,200|
|Tax at 40% (B)||£2,080|
Profit after tax (A)-(B) £3,120
|Pre-tax profit (A)||£5,200|
|Tax at 40%||£4,000|
Less mortgage interestrelief (20% of £4,800)
|Total tax due (B)||£3,040|
Profit after tax (A)-(B) £2,160
In short, while basic-rate tax payers will see no difference, a higher-rate tax-paying landlord letting a property for £1,000 pcm with a mortgage interest payment of £400 a month, could see their profits fall by almost a third over four years, if they are unable to increase rents or reduce costs to cover their increased tax liability.
Bear in mind with these changes in how letting income is calculated, it may even affect you if you are not currently paying a higher rate of tax, but the new system pushes you into that bracket. So if this might be you, or you are already paying tax at 40% or 45%, make sure you have planned ahead, calculated what the loss of this deductible allowance will mean for you and – most importantly – know whether your investment will still generate a profit.
Personal allowance – some good news!
Making a small dent in any loss of profits is the raising of the tax-free personal allowance for 2017-18, from £11,000 to £11,500 - although this will not be of much comfort to landlords with larger, more profitable portfolios, who may see a drop in those profits by 2021.
Council Tax changes
In his Autumn Statement, the Chancellor also announced the introduction of a ‘double council tax’ charge for empty homes. Local authorities have been given the power to levy a 100% council tax surcharge on properties that stand empty, in a move intended to dissuade investors and second-home owners from ‘wasting’ valuable accommodation. While this might be a good sentiment, it’s unlikely to affect more than a very small percentage of well-capitalised landlords, as the vast majority are letting their properties for income. As such, it is unlikely to result in these properties suddenly appearing on the rental market and will probably simply be a financial irritation for wealthy second home owners.
Freezing of indexation
The final piece of new tax legislation that could impact buy to let investors is the freezing of ‘indexation’ from January 2018. This is a tax relief available to business – including landlords who have bought their buy to lets within a company structure – that offsets the effect of inflation over time on capital gains.
Under the current system, when companies sell an asset, HMRC supplies an indexation allowance – a figure that relates to the period of time the asset has been held. The original purchase price is multiplied by this figure and that amount is deducted from the gain; the remainder is liable to corporation tax.
The effect on incorporated landlords who already hold property is that there will be no further relief from January, although historical relief will still be applied when they sell. For landlords who buy property within a company from now onwards, the full capital gain will be liable to corporation tax when the property is sold.
All tax can be complicated, but property tax has very specific rules, so it’s sensible to take advice from an expert in the field to make sure you are declaring everything you should, while mitigating your tax liability.
This information has been provided by our partner Mortgage Advice Bureau. For more information relating to Mortgages or for Mortgage Advice please visit Mortgage Advice Bureau.