If you’re an individual with a mortgage on a buy-to-let property, you may end up paying more tax from 6 April 2017. HMRC is changing how mortgage interest is treated when calculating tax on income from buy-to-let properties. These buy-to-let tax changes will be phased in over four years.
How buy-to-let property is taxed presently
Currently, you can take the interest on the mortgage as a “deduction” from the gross rent to achieve the taxable profit figure. It’s not an “expense” so you can’t make a loss, but you can deduct all interest paid up to the point of reducing your tax bill to zero. HMRC are introducing changes from April this year to instead treat the deduction as a “Tax Reducer”. Sounds similar, right? But this change makes a big difference.
The buy-to-let tax changes
Instead of taking the entire amount of interest from the gross rental, first the tax is calculated and then a reduction is made for the interest paid on the loan. However, this is capped at 20% of the interest paid.
We’ve run some sums and the main impact here will be for those being taxed at the Higher or Additional Rates. It’s worth noting however that you may become a Higher Rate taxpayer because of this, as your taxable income will be increased.
Buy-to-let tax, current setup vs future set up
HMRC will phase this change over a four-year period as follows:
- 2017/18 Tax Deduction 75% Tax Reducer 25%
- 2018/19 Tax Deduction 50% Tax Reducer 50%
- 2019/20 Tax Deduction 25% Tax Reducer 75%
- 2020/21 Tax Deduction 0% Tax Reducer 100%
This applies to individuals but not companies.
It applies to residential but not furnished holiday lettings or commercial property.
Potential consequences of the buy-to-let tax changes
- Create tax liabilities where previously there were none.
- Push those currently happily a Basic Rate taxpayer into the Higher Rate.
- Increase income to a level that will impact the Child Benefit Tax Charge.
- Could push you above the £100,000 threshold and begin to lose your Personal Allowance.
What options are there to consider with the buy-to-let tax changes
- Could you transfer part ownership to your spouse? Spread the income and therefore tax.
- Could you convert to a Furnished Holiday Letting? There are criteria that need to be met and potential VAT implications of this move.
- Consider transferring the property into a Limited Company. Not only would you be receiving the mortgage interest as a deduction, but you would also have the rental taxed at 19% Corporation Tax rate from 1st April 2017, which reduces to 17% by 2020 (instead of 40% at the High Rate or 45% at the Additional Rate). Adopting this approach requires careful consideration, as there is a risk of losing the Entrepreneurs Relief on your shareholding in the company, depending on the value of the property and your company turnover.
- At the transfer, the individual would create a Capital Gain on which tax is due once any available reliefs have been applied. Stamp Duty would be payable by the company depending on the market value of the property. It’s also worth noting the property would be at risk if the company was to get into trouble, so this is an area where you should seek advice before doing anything.
- Could you make a long term move and consider moving the property into a partnership? Although you would still feel the changes of mortgage interest treatment, you would then be open to claim relief on Stamp Duty when moving the property into a Limited Company. Additionally, we would have more scope for proving the rental is a business and look at Rollover Relief on the Capital gain at time of transfer to the Ltd Company. You would need a partner, a formal partnership agreement, separate bank account and be running for a few years as a partnership before incorporation.
- Could the best option be to repay the mortgage debt or potentially even to sell the property?
Plan for the buy-to-let tax changes
Each individual situation is different. If you have a rental property (or portfolio) it’s really important that you plan for the future so you don’t pay more tax than you need to. If you’d like to chat to one of our property tax experts about the best options for you, please call the office on 0345 201 1580 or email firstname.lastname@example.org. We’re here to help.