You must know about changes to the Buy to Let tax relief if you own, or want to purchase an investment property in the UK. Changes to this tax relief affect your property income and profit.
Firstly, a Buy to Let is an investment property that is rented to tenants. Landlords cannot live in their Buy to Let property.
Changes to the Buy to Let tax relief
Before April 2017, landlords could claim their mortgage interest and finance costs (mortgage fees and fees for purchasing furnishing) as a tax deduction. And so, the higher your mortgage interest and finance costs were, the more tax deduction you could claim. Thus, higher earning landlords paid less tax on their property income.
The U.K Government declared that this was not a ‘fair system’ as higher earning landlords were claiming more tax reliefs. And so, in April 2017, the U.K. introduced new laws to gradually replace the tax deduction on mortgage interest and finance costs, with the basic income tax rate. These changes will be phased over a four year period.
The basic income tax rate is same tax your employer deducts from your salary. At time of writing, you pay a 20% tax on income between £11,851 to £46,350. For higher earners, you pay an additional 40% tax on an income between £46,351 to £150,000.
The basic income tax system is not favourable for property investors because the more you earn, the more tax you pay. Whereas, under the old Buy to Let tax relief system, the higher your mortgage interest and finance costs were, the less tax you paid.
Below is a case study of how the Buy to Let tax changes has affected one landlord’s property income.
How the Buy to Let tax changes could decrease your rental profits
Jennifer earns a salary of £35,000 and a rental income of £18,000 per annum. Her mortgage interest is £8,000 per year, and she claims £2,000 on allowable expenses.
Allowable expenses include council tax, insurance, letting fees, ground tax, gas and electricity, accounting fees and other costs that are spent solely for the purpose of renting the property out.
Here is a graph demonstrating how the Buy to Let tax changes affect Jennifer’s property income each year:
|Before April 2017||April 2017 / 2018||April 2018 / 2019||April 2019 / 2020||April 2020 / 2021|
|Deduct mortgage interest and finance costs||- £8,000 (100% of the interest and finance cost is tax deductible)||- £6,000 (Only 75% of the interest and finance costs are now tax deductible)||- £4,000 (Only 50% of the interest and finance costs are now tax deductible)||- £2,000 (Only 25% of the interest and finance costs are now tax deductible)||- £0 (The interest and finance costs are no longer tax deductible)|
|Deduct allowable expenses||- £2,000||- £2,000||- £2,000||- £2,000||- £2,000|
|Tax owed (Tax is calculated at the basic income tax rate)||£6,230.00 (Less tax is paid because the interest and finance costs are 100% tax deductible)||£6,630.00 (More tax is paid as only 75% of the interest and finance costs are now tax deductible. The remaining 25% of her income is now taxed at the basic tax rate.)||£7,160.00 (More tax is paid as only 50% of the interest and finance costs are now tax deductible. The remaining 50% of her income is now taxed at the basic tax rate.)||£7,960.00 (More tax is paid as only 25% of the interest and finance costs are now tax deductible. The remaining 75% of her income is now taxed at the basic tax rate.)||£8,760.00 (More tax is paid than previous years as 100% of her income is now taxed at the basic tax rate)|
According to the above graph, Jennifer’s taxable income and tax owed increases each year under the Buy to Let tax changes. Like Jennifer, many property investors will be pushed into a higher tax bracket, especially if you have more sources of personal income, such as pensions, shares, businesses, etc.
Is the Buy to let tax changes really creating a fair system? Obviously, no one wants to pay more tax, including myself.
However, like death, tax is non-avoidable. Don’t waste your time over-analysing the implications of the tax relief changes. Instead, focus more on managing your cashflow, as you will have to pay more taxes in the coming years.
So, do you think changes to the Buy to Let tax creates a fairer system?
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