Mortgage interest which was previously deductible as a tax allowable expense for private landlords will now be allowable as a deduction, only at the lower rate of income tax. Landlords falling into the higher rate tax band will pay more tax.
The loss of relief is being phased in from 2017/18.
The lack of tax relief will push many landlords, into a loss making position.
For example; Monthly rent on Property £750, (£9,000 per annum). Mortgage interest is 5% on £130,000 mortgage, (£6,500 per annum). Other tax allowable expenses, annually are £500.
The taxable profit to a landlord who is a higher rate taxpayer is £2,000, on which he pays £800 in income tax. In effect the mortgage interest has attracted tax relief at 40%. Post tax profits are £1,200.
Under the new rules the mortgage interest is allowable only at the lower rate of tax , 20%, so £6,500 x 20% = £1,300 of tax relief is lost. The income tax bill increases by £1,300. The tax payer is in a loss making position.
What are the solutions..
Fortunately the changes are being phased in over time so there is time to act.
- Transfer property portfolio into a limited company. Mortgage interest relief remains fully tax allowable for corporation tax purposes. However, this requires careful consideration / detailed planning as there may be a capital gains tax charge on the way in. The rules for dividend income has changed from 6th April 2016; the first £5,000 are tax free, then taxable at 7.5% for lower rate taxpayers and then 32.5% for higher rate tax payers.
- There may be an opportunity to assign the property rental income to a spouse who has is not using their lower rate bands.
- Re-mortgage to reduce the interest rate charge.