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Residential landlord? Watch out!

13/08/2017

Residential landlords who haven’t been reading The Money Pages could be in for a shock when they come to prepare their 2017-18 tax returns.

Why?

Because the government has begun to restrict the tax relief on finance costs (including mortgage interest) available to landlords who don’t trade through a company.

Until now things have been pretty simple. In preparing your annual tax return you included your finance costs in the expenses you deducted from property income to calculate your taxable profit. This taxable profit was then subject to income tax at your marginal rate.

Here’s a simple example that showcases how things have been:

Caroline receives rental income of £50,000 a year. This is her only source of income.

Interest of £20,000 is payable each year by Caroline on the mortgages funding her properties

Property income         £50,000

Property expenses      (£20,000)

Taxable profit             £30,000

Income tax due

0% tax on PA of £11,000                                £0

Tax at basic rate of 20% on next £32,000      £3,800

Tax at higher rate of 40% on remainder        £0

Income tax payable                                        £3,800

Going forward things are going to be different…

Starting with your 2020-21 return you will no longer be able to deduct finance costs when calculating your taxable profit. Instead you will be only be able to deduct tax relief at the basic rate on your finance costs from your income tax payable

Here’s an example that showcases exactly what this means and how Caroline would fare under the new regime for 2020-21

Caroline receives rental income of £50,000 a year. This is her only source of income.

Interest of £20,000 is payable each year by Caroline on the mortgages funding her properties

Property income         £50,000

Property expenses       £0

Taxable profit             £50,000

Income tax due

0% tax on PA of £11,000                                £0

Tax at basic rate of 20% on next £32,000      £4,200

Tax at higher rate of 40% on remainder        £7,200

Subtotal                                                           £11,400

Less tax relief on finance costs (20K*20%)   £4,000

Income tax payable                                        £7,400

As you can see, the new rules would have quite an impact on Caroline and would raise her income tax liability from £3,800 to £7,400. Quite a jump.

And why does this matter now? Because between now and your 2020-21 return transitional rules will apply that will slowly move landlords from the current to the new situation. Full details of these rules can be found here.

So what should residential landlords do?

Well, the new rules only affect landlords that do not trade through a company, so, is there perhaps a case for moving your properties into a company?

Tread carefully! Any such move would be treated as a sale by you to the company and should only be considered after having obtained professional advice from your accountant or lawyer as it would likely cause your capital gains to crystallize.

Yes, it’s a bit of a minefield for landlords at the moment.

Watch this space for further updates on the latest issues landlords need to be aware of.

 

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