What effect do the recent changes to UK taxation have on a landlord with employment income of about £40K and a unfurnished rental property that just about breaks even? (E.g. the rent just about covers the mortgage interest payments and other costs. Most landlords in the UK have interest only mortgages.)
Until the changes in the Budget 2015, landlords paid tax on their profit; now landlords pay tax on their “turnover”. So a landlord can be required to pay tax on rental income even when the mortgage interest costs are more than the rent!
The government claims it will only affect higher rate (40%) taxpayers; this is not true, as a lower rate taxpayer can be taken into the higher rate tax due to these changes. The effect is very dependent on a landlord’s income and cost, including non-rental income, so each landlord has to do their own detailed investigation of how they will be affected. There are many calculators on the web to help with this.
To quote an example from Phil Ashford blog (one of the best write ups of this I have seen):
Let's do an example and bring this to life. Your name is now Ben/Laura, take a pick(!), and you earn £41,800 at your 9-5pm job. You also do quite well and get a £1,500 Bonus! When you got married you moved into your partner's house and you rented out your home as you found it difficult to sell.
You rent it for £600 a month and pay Interest of £500 a month on your mortgage. You have management and general repair costs of, on average, £100 per month. Neat example, because you make no money! You have therefore never before declared Rental Profits because £600 - £500 - £100 = £0 Rental Profits. You have never had to pay HMRC tax for making no money from your rental property,
"Of course, who would have to pay tax when you don't make profits?!". Well, from 2017, you do! You will start paying tax, and in 2020 with all other income still being the same, you'll have to pay £1,040 in tax for your rental property, compared to 2016 when you would pay £0. There's an obvious problem isn't there.
Your yearly profits from property are ZERO, yet you will have a tax bill of £1,040. It's lucky you got that Bonus! After tax and ignoring National Insurance, you'll have £1,200 in your bank account from your bonus, but, instead of treating your family for your extended hours at work recently, you'll simply pay most of it straight to the tax man to settle the tax bill on your £0 Rental Profits.
(He then shows the effect of a small change in interest rates etc.)
This is another worked example from the Telegraph:
The landlord, pay 40pc tax.
NOW Your buy-to-let earns £20,000 a year and the interest-only mortgage costs £13,000 a year. Tax is due on the difference or profit. So you pay tax on £7,000, meaning £2,800 for HMRC and £4,200 for you.
2020 Tax is now due on your full rental income of £20,000, less a tax credit equivalent to basic-rate tax on the interest. So you pay 40pc tax on £20,000 (ie £8,000), less the 20pc credit (20pc of £13,000 = £2,600), meaning £5,400 for HMRC and £1,600 for you. Your tax bill has therefore gone up by 93pc.
Now, say Bank Rate – and in turn your mortgage rate – rises by a small fraction, lifting your mortgage cost to £15,000, while your rent remains at £20,000. You will have to pay £5,000 tax in this scenario, so you make no profit at all.
Now we have some idea of the effect this may have, here are some details.
- You used to deduct all your allowed costs (including mortgage interest payments) from the rent to arrive at a profit figure, then pay tax on this profit.
- Now you deduct all your allowed costs (excluding mortgage interest payments) to arrive at a “taxable turnover figure”; you then get a tax credit of 20% of your mortgage interest payments.
This is being phased in over 5 years, so no need to panic today about it.
Landlords are still debating what do so; some will try to put rents up, others are going to evict their tenants and sell all their properties. Personally, we are not badly affected by this, so we will just provide less rental accommodation then we may have done so otherwise.
I know of one GP that is going to start working part time (currently working full time), as their earned income will have an effective marginal tax rate of 65% due to the way it affects the tax on their rental property. I rather expect this is not the outcome that the government wished for...
Assuming no other taxable income or tax deductions, then from April 2017 the landlord will be paying higher-rate tax (40%) on income over £43,600 and will only be able to claim basic-rate (20%) tax relief on mortgage interest, phased in over four years. If mortgage interest is the only cost and it's exactly the same as the rental income, then the landlord will lose 5% of the amount by which the annual mortgage interest payment (or annual rent, since they're the same under this assumption) exceeds £3,600 in 2017-2018, 10% in 2018-2019, 15% in 2019-2020 and 20% in 2020-2021 and subsequent tax years. Except that the higher rate threshold, employment income and rent are likely to have increased in the later years.