Your property rental profits are going to increase considerably this year and yet you’ll have no extra money in your pocket.

In fact, you may feel poorer as your tax bill may go up and allowances may go down.  So, what’s happening?

 


Mortgage interest no longer 100% deductible for tax

You may recall, back in 2015, we explained that finance costs were being restricted.  Largely this means that the interest you are charged on your buy-to-let mortgage is no longer 100% deductible as an expense.

Instead the government introduced restrictions to taper the interest relief over a number of years until 6th April 2020 when there will be no relief permitted for finance costs.

The knock-on effect of the interest restriction last year, in the 2017/18 self-assessment tax returns, will have been relatively minor as only 25% of interest was blocked, but in 2018/19 the restriction was 50% and therefore the tax returns we are currently preparing look rather more unpleasant, with next year’s looking highly unattractive.

Profit forecast

The interest restriction means that your property profits will increase.  This means that your taxable income will have grown since last year and therefore your tax bill (and payments on account) may also be going up.

In many cases this is pushing clients into a higher band for tax.  In 2019/20 the tax bands are as follows:

Band Taxable income Tax rate
Personal Allowance Up to £12,500 0%
Basic rate £12,501 to £50,000 20%
Higher rate £50,001 to £150,000 40%
Additional rate over £150,000 45%

An Example

Up to 2017 you could deduct your mortgage interest and other allowable expenses from your rental income to determine your property profits, for example:

  • £10,000 rental income
  • £5,000 mortgage interest costs
  • £1,000 other allowable expenses
  • = £4,000 profit from property rental

 

These profits were combined with your other sources of income and you were then taxed at your marginal rate, so a basic rate taxpayer would pay £800 in tax (£4,000 x 20%) and a higher rate taxpayer would pay £1,600 in tax (£4,000 x 40%).

From 2020 you will no longer be able to deduct mortgage interest from your profits, therefore using the same figures the outcome is as follows:

  • £10,000 rental income
  • {£5,000 mortgage interest costs NO LONGER DEDUCTED}
  • £1,000 other allowable expenses
  • = £9,000 profit from property rental

 

Instead of deducting the mortgage interest HMRC will allow landlords to claim a basic rate allowance for finance costs at 20%. Therefore £1,000 can be deducted from the tax bill (£5,000 x 20%).

So in this example a basic rate taxpayer still only pays £800 (£9,000 x 20% MINUS £1,000).  However a higher rate tax payer now owes £2,600 (£9,000 x 40% MINUS £1,000).

Note that despite the £9,000 ‘profit’ HMRC calculate, you still only have £4,000 in your pocket at the end of the year (£10k rental income less £5k mortgage costs less £1k other expenses).

Unintended consequences

From this example it would appear that a basic rate taxpayer is unaffected, however note that the taxable profit has increased from £4,000 to £9,000.  This is a large jump and when combined with other income from PAYE employment, self employment, dividends etc. may drag the taxpayer into the higher rate band (as their total taxable income has increased).

Remember that it is the amount of taxable income that determines eligibility for many allowances and below are just some of the ways in which clients are feeling the impact of these higher property rental profits.

Tax on Dividends

Possibly the most painful result of the finance restriction on property profits will be in relation to tax on dividends.  As dividends are taxed as the highest slice of income, the interest restriction could push the dividend income into a higher tax band, attracting tax at 32.5% or 38.1% rather than at 7.5%.

Parents hit

The high-income child benefit charge (HICBC) prevents families from receiving child benefit where one parent earns over £60,000 (tapered from £50K).  The finance restrictions may push one of the parent’s earnings above this band therefore removing the child benefit payments for the whole family.

In addition, where one or both parents has taxable income over £100,000, they are not eligible to have a tax-free childcare account. Breaching this income threshold will also mean the family loses entitlement to 30 hours free childcare.

Finally, parents who are liable to pay child maintenance will find they must pay larger amounts based on their taxable income.

Savings income

Taxpayers who have significant savings income may enjoy their interest tax-free where it is covered by their personal savings allowance (PSA).  The PSA is set at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers, but is withdrawn for those in the additional rate band.

The finance restrictions may reduce the savings allowance to £500 or nil, making some or all of the interest income taxable.

Capital Gains Tax

The rate of CGT payable on the disposal of an asset is dependent on the level of the taxpayer’s taxable income in the year that the asset was sold. The finance restriction could result in the taxpayer paying CGT at 20% rather than at 10%, or at 28% on residential property gains rather than at 18%.

Student loans

Individuals who have outstanding undergraduate student loans have to pay 9% of their taxable income above these thresholds:

  • £18,935 for plan 1 loans
  • £28,725 for plan 2 loans

 

Those who have also taken out a postgraduate loan must pay an additional 6% of their taxable income above £21,000 from 6 April 2019. The finance restriction could easily push a landlord over these thresholds.

Other areas

  • The personal allowance for tax free earnings, is tapered away for those earning over £100,000.
  • Pension annual allowance is reduced for high earners.
  • Marriage allowance is withdrawn where taxable income exceeds the basic rate band.
  • Scottish taxpayers have more tax bands and could therefore be pushed into a higher band sooner than others in the UK

Note.  This restriction does not apply to corporate landlords, or those letting furnished holiday lettings or commercial property.

If you are concerned about how the changes will impact your finances then give the a4c office a call on 01737 652 852.