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There’s BIG Tax Changes For Landlords In 2019!

April 2019 marks the third phase of the Government’s plan to progressively reduce the amount of tax relief on buy-to-let interest mortgages. Benjamin Brain, Director at Hannells, explains what these changes mean and how they affect you

Back in 2015 George Osborne announced a change in the way Landlords pay tax on their property earnings.

Before we go any further, it’s worth noting that this only applies to Landlords who purchase their properties as individuals and not through a company, so if you’ve “incorporated” you won’t be subject to these changes.

Also, if you’re a “Basic rate tax payer”, whilst the way you calculate your tax will be different, the amount you pay remains largely the same as before.

BUT that doesn’t mean you should stop reading here.

Many Landlords who thought they were Basic rate tax payers have now been, many unknowingly, pushed into the Higher rate tax band and could be receiving a nasty surprise come tax return time.

The changes mean that Landlords in the “Higher rate” and above thresholds have seen, and will continue to see, their tax bills increase significantly.

In the past, Landlords have been able to declare rental income after having paid their mortgage interest payments – saving £1,000’s in tax payments.

Basically, you paid tax on your rental profits once all costs, including interest payments, had been deducted.

The Government decided that this was no longer acceptable and introduced a plan to totally phase out mortgage interest tax relief by 2020 and instead replace it with a 20% tax credit.

Rather than going straight for the jugular and eliminating the tax relief immediately, they decided to implement a staged reduction which has seen the tax relief reduced gradually over a period of four years, as shown in the table below:

Tax Year
Proportion of mortgage interest deductible under the previous system
Proportion of mortgage interest that qualifies for the 20% tax credit under the new system
Prior to April 2017
100%
0%
2017 – 18
75%
25%
2018 – 19
50%
50%
2019 – 20
25%
75%
2020 onwards
0%
100%

There’s no getting round this – it’s complicated, so I’ve done my best to provide a breakdown of how these tax increases work.

If you’re finding yourself regularly having to “double-take” throughout this article, don’t worry. You’ll find yourself in the company of many hugely experienced property professionals and Landlords who have been just as baffled.

So, here’s an example of how a Landlord’s tax bill will be affected by these new changes in 2020 (plenty more examples to come). Here we go;


PRE-“NEW SYSTEM”

  • £10,000 Rental Income
  • £5,000 Mortgage Interest Payments
  • £1,000 Other Costs (Management Fees, Maintenance etc.)
  • = £4,000 Profit.

Under the old rules, you’d be taxed (according to your personal tax threshold) on the profit left once mortgage interest payments and costs had been accounted for.

So, a Basic rate tax payer (20%) would receive a bill for £800 on the above calculations.

A Higher rate tax payer (40%) would receive a bill for £1,600.

 

ONCE RELIEF TOTALLY PHASED OUT (APRIL 2020)

  • £10,000 Rental Income
  • £5,000 Mortgage Interest Payments – ** NOT DEDUCTED **
  • £1,000 Other Costs (Management Fees, Maintenance etc.)
  • = £9,000 Profit

So now, the mortgage interest payments are not included as a deductible “cost of business” and rather than being taxed on the profits, Landlords are being taxed on their turnover – big difference.

As a Basic rate tax payer, you’ll owe £1,800 in tax (20% of £9,000) but you’ll claim back a 20% tax credit on your mortgage interest of £1,000 leaving you with a total bill of £800 (same as before).

However, for a Higher rate tax payer, you’re going to be hit with a bill for £3,600 (40% of £9,000) and then claim back a 20% tax credit on your mortgage interest of £1,000, leaving you with a final bill of £2,600.

That’s £1,000 more than under the previous rules.

There are two potentially portfolio devastating effects of this new system, one more obvious than the other.

Firstly, it means many portfolios that were previously generating a healthy profit each year have been turned into loss making burdens – hence the appearance of regular stories featuring Landlords with vast property empires deciding to sell up.

Secondly, because earnings are now calculated on turnover many unsuspecting Landlords have been pushed up into the higher earnings tax threshold without even realising.

If you take the examples given above, without doing anything different, our Landlord has now (according to the tax man) earned £5,000 more because of the new system.

If you think you’re sitting pretty as a 20% Basic tax payer, it might be worth taking a look into your finances to make sure that you haven’t crept into the 40% club.

April 2019 marks the start of the third phase of this new system.

Landlords will only be able to deduct 25% of their mortgage interest under the previous system and 75% will qualify for the 20% tax credit under the new system.

It all sounds very confusing, and it is.

Completing self-assessment tax returns has been made all the more complicated leaving many Landlords totally clueless as to what exactly they should be expecting to pay in tax.

Below is an example of how our Landlord would work out his tax obligations for the upcoming financial year:

 

APRIL 2019/20 TAX PAYMENT CALCULATION

  • £10,000 Rental Income
  • £5,000 Mortgage Interest Payments

    • 25% can be deducted (£1,250) from total Rental Income
    • (A 20% tax credit is applied to the remaining 75% (£750 tax credit))
  • £1,000 Costs (Management Fees, Maintenance etc.)
  • = £7,750 Profit (Rental Income (£10,000) minus 25% Relief (£1,250) minus Costs (£1,000))

So, this now results in High rate tax payers being billed for 40% of the £7,750 profit, which is £3,100, with a tax credit on the mortgage interest payments of £750 being claimed back (20% of £3,750).

Our Landlord receives a total tax bill for 2019/20 of £2,350.

It’s not quite the £2,600 that he’ll be expected to fork out in 2020 (and beyond) but it’s still a sizeable chunk and it’s far more than Landlords have been used to budgeting for when reviewing their property investments or when looking to acquire more.

Given that historically, most Landlords with more than one property in their portfolio have opted to go for interest only mortgages due to the tax benefits and lower monthly payments, this is going to affect a LOT of people.

In conversations with existing Landlords and those who are interested in taking a dive into the world of property investment, this usually raises one of two questions.

The first is;

“What happens if I have a repayment mortgage instead of an interest only mortgage?”

The answer is, ONLY the interest part of the mortgage payment can be treated as an expense when working out your rental profit or loss for tax purposes.

The capital part of your mortgage payment isn’t a deductible allowance so it doesn’t enter the equation.

The second question is;

“Does that mean I should incorporate and run my investments through a holding company?”

Unfortunately, the answer isn’t clear-cut (but you knew I was going to say that!).

Yes, there are benefits to incorporating as you’ll be subject to the standard corporation tax of 20% rather than the personal tax rate of 40% for those inthe High rate threshold.

However, there are also disadvantages to incorporating.

If you want to take profits out of your holding company (paid as dividends) the tax-free allowance has just this year been reduced from £5,000 to £2,000.

As a High rate tax payer, you could be paying up to 32.5% in dividend taxes on anything you draw out of the company, plus your 20% corporation tax.

An “individual” High rate tax payer would pay 40% on £1,000 of profit, leaving you with £600 (plus the 20% credit on mortgage interest payments).

As a “holding company” you’d pay corporation tax of £200 on the £1,000 profit leaving you with £800.

Then (assuming you’ve exceeded your £2,000 tax free dividend allowance) you’d pay another 32.5% dividend tax leaving you with £540.

So in this scenario, you’d actually be at least £60 worse off with a holding company.

Not to mention the capital gains taxes and additional stamp duty land taxes that you may incur in transferring a property from an individual to a holding company.

The answer to this question really depends on what your investment strategy is and how you plan to use the profits you generate.

If your goal is to replace your wage with the income from your property profits and you’ll be drawing down dividends regularly, you would decide on a different tax strategy compared to an investor who is more focused on allowing the profits to build over a substantial period of time (for example, until they are no longer in employment so their tax position changes) to use for the purchase of another property.

I think it’s fair to say that this is all massively confusing but I hope that by reading this article, you’ve at the very least gained a better awareness of how this new tax system could affect you, or anyone else that you know who might be involved in property.

If your next thought is “What do I do next?”

My answer is simple and applies to all.

Speak to a qualified property tax specialist – of which I am not.

They are by far the best suited people to advise you on the best course of action to suit your personal circumstances – of which everyone’s are different.

There is no “one-size-fits-all” solution to this.

The cost of one trip could literally save you £1,000’s each year and if you plan on being involved in property for a good few years to come, that adds up to quite a considerable sum.

Whilst it may not be easy to hear, it’s far better to be prepared for increased tax bills and start budgeting accordingly.

There will be many Landlords that choose to stick their head in the sand and hope that they won’t be affected – a term that could be dubbed the “Ronaldo Syndrome” as it’s been revealed today that he too has been hit with a £16,500,000 (yep, £16.5 million) fine for avoiding paying his taxes a few years back.

Unfortunately, that way of thinking is going to result in many Landlords coming unstuck with potentially bankrupting consequences.

As far as I can tell, property is still (and will continue to be so for a long time to come) one of the smartest ways to invest your money, generate a healthy income stream and build a great pension pot.

For the Landlords who are working towards a defined strategy, have invested in making sure their affairs are set up in the most tax efficient way and are extremely diligent with their numbers – making sure that everything stacks up incredibly well before making a purchase – there will potentially be more opportunity than ever as increasing numbers of investors drop out of the market as the climate becomes more and more challenging.

As always, every cloud has a silver lining…

Good luck to all!

Benjamin Brain

Director

Hannells

Hannells – A Moving Experience…

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