The big rental sector news over late 2016 and the New Year was the Government’s decision to limit the tax relief available on buy-to-let properties. These revolutionary changes were outlined in the 2015 Autumn Statement presided over by former Chancellor of the Exchequer, George Osborne, with a large proportion of the buy-to-let market expected to be affected by these changes.
As it stands, landlords can offset their mortgage interest against their income tax, but from April 2017 this benefit will be cut quite significantly, until it will eventually be replaced by a universal 20% tax credit in 2020. In addition, after 2020, Britain’s landlords will see themselves paying tax on their rental revenue rather than just on their profit, which is the current system in place. This is part of the Government’s four year phase-in, during which time a tiered structure will be put in place.
The upcoming tax changes:
| Tax year | Percentage of finance costs deductible from rental income | Percentage of basic-rate tax reduction |
|---|---|---|
| 2017-2018 | 75% | 25% |
| 2018-2019 | 50% | 50% |
| 2019-2020 | 25% | 75% |
| 2020-2021 | 0% | 100% |
Including rental revenue with landlords’ regular income before their tax rate is applied could have a serious implication for landlords—the National Landlords Association calculates that this decision could push as many as 440,000 or more landlords into a higher income tax bracket, which has the capacity to severely impede their current and future profits.
To give an idea of the impact that this could have on landlords, mortgage broker London and Country in an article by This is Money presents the example of a basic-rate taxpayer with a buy-to-let property that currently lets out for £15,000 per year on an interest-only mortgage that costs £10,800 per year. Under the current system, the property’s rental income is £4,200 as the landlord is able to deduct that mortgage interest before deducing their taxable income. However, from April 2017 the property’s entire rental income would be added to the landlord’s existing salary—so if a landlord’s fixed salary is £35,000, they would be judged to have a total income of £50,000 (their salary plus the property’s total rental income) rather than just £39,200. This difference of £10,800 is enough to push the landlord into a higher tax bracket, meaning paying a higher rate of tax on everything.
Whilst the introduction of the Government’s new 20% tax credit against mortgage interest should limit the damage felt by landlords on a basic rate of tax, those in the higher rate tax bracket will see their returns significantly dwindle, as they are the fraction with the capacity to lose 40% tax relief.
This has naturally led to landlords considering whether they should make up this shortfall by raising the rents in their buy-to-let properties to alleviate the financial strain they may soon find themselves in. Data collected from the Residential Landlords Association suggests as much, with around two-thirds of its members saying they are set to put up rents to cope with the cost of the changes. Of those who said they will put up their rents to combat the new restrictive legislations, a third said they will increase rents by around £300 next year, while a further third said the rise would be closer to £600—and 7% plan to charge an extra £1,200 per year.
For this reason, the National Association of Landlords is lobbying to stop these changes from taking effect, bemoaning the huge financial ramifications this could have on thousands of British landlords. This could also be at the detriment of tenants, who may have to make up this financial shortfall through increased rent, which could cause rents to skyrocket even further across the entire nation. At the time of publication nothing concrete has been put to Parliament regarding these tax changes, but it’s expected that the tax changes will go ahead as planned, being phased in gradually from April 2017.
