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Mortgage Interest Relief. What's going to happen next?

Mon 06 Feb 2017

If you are not already aware, landlords and investors will be subject to potentially huge taxation increases. Currently landlords are able to offset the amount of interest they pay on their mortgage, against their tax bill. This means that, as with any other business, landlords are taxed on the proft they make. However, from 2017 this is all changing with the government phasing in a reduction to the amount they will not get relief on which will be in 25% increments over 4 years.

 

The phased-in changes to the amount of finance costs that you will be able to deduct from rental income between 2017 and 2020 will be:
•Between 2017 to 2018: 75% of finance costs
•2018 to 2019: 50% of finance costs
•2019 to 2020: 25% of finance costs
•From 2020 on-wards: 0% of finance costs with basic rate tax reduction at 100%

 

Private landlords are providing a vital service to an already stretched housing market, and are subject to over 400 regulations, with far reaching requirements on property conditions, health and safety, deposit protection, and right-to-rent. Moreover, landlords have to be on call 24-7 for any problems with their properties. It is forecast that 60% of landlords will be pushed into the higher rate of tax from the removal of mortgage interest relief even though their income has not increased. This could have huge implications for landlords, including reductions of your personal tax allowance and impact on tax credits.

Here's an example to put this into context:

A landlord, after paying all his other expenses, has a net rent for a property for a year of £7,000.  His mortgage interest for that year is £3,500. If he can deduct mortgage interest he pays his tax on £3,500 at 20% which means a tax bill of £700.  If, on the other hand, the interest is not tax deductible his tax bill becomes £1,400.

From this example, the loss of mortgage interest relief doubles the amount of tax being paid by the landlord, we argue this change will reduce the amount of investment in the private rented sector, reducing current standards of housing and reducing supply. We haver already seen even in a small area, in a reasonably short amount of time that it has also lead to substantial rent increases as landlords attempt to claw back the money that will be 'lost'.

A further impact of these changes could be landlords making a loss due to these changes. An example of this is:

A rental property is purchased for £200,000 yielding a rent of £750 per month, which is an annual rental income of £9,000 a year. The running expenses are £1,000 p.a. leaving an income after these expenses of £8,000 p.a. There is a mortgage at 65% of the value of the property of £130,000 on which the landlord is paying 5% p.a. interest on an interest only loan, with interest at £6,500 p.a. This leaves a net income before tax of £1,500 p.a.

With mortgage interest relief, the tax (at 20% rate) is £300, which leaves the landlord with £1,200 net profit. Overall, this equals a 1.7% return on the equity investment made by the landlord (on the £70,000 capital invested by the landlord).

After mortgage interest relief is removed, the amount of tax payable rises to £1,600 at the 20% rate. On the £9,000 a year rental income after the £1000 running expenses, this leaves income of £8,000. After the interest of £6,500 and the tax bill of £,1600, this leaves a net loss of £100 after tax. This represents a negative return on investment on the landlord’s own equity.

In both of these examples, nothing is included regarding void periods, or rent arrears which you can see there is zero breathing space for. Furthermore, if a landlord has other income, then the tax rate can quickly increase to 40% and makes this situation even worse for the landlord. In either situation, this is increasing the rate of tax for buy-to-let landlords with harmful consequences for the sector.

 

What can be done? Well, the obvious option for landlords with multiple properties would be to pay a lump sum off their mortgages in order to bring the monthly interest charges down but realistically, there are few landlords who will have that amount of 'spare cash' to play with.

It seems the idea is to fend off Buy-To-Let investors in attempt to open the door for first time buyers and increase the number of UK home owners. With what we have already seen, there was been a fall in the level of investor enquiries and record high for agents with first time buyer's on their books. The reality is that yes, some landlords will be put off, and may even sell, however in forging this pathway for first time buyers it will leave a whole lot of new problems behind.

An increase in rents meaning tenants are worse off, a further shortage in an already stretched rental market which will lead to further rent increases, and investors finding loop holes in the system such as selling their properties to themselves in a Limited company to try and escape the extra charges. Even this will not be a solution to all however, as with this method there will be stamp duty and capital gains tax to pay, along with a host of other charges.

To conclude, no other business is taxed in this way, so why the private rental sector? Since it's announcement the news had made international headlines, and has been labelled as one of the most hostile tax laws in western civilisation.

Many are supporting a campaign against these new tax laws, and for article 48 to be revised in Parliamament.

If you have any questions or queries that you would like to discuss, feel free to contact one of the Ferndown Estates team where we will discuss any grey areas with you.

"Ferndown Estates helped us sell our home with the minimum of fuss with a calm, attentive and professional demeanour. Always available, always positive, always supportive "
B Holt. April 2017