The UK rental market is undergoing a major shift due to recent changes in tax laws affecting landlords. These changes center on the mortgage interest tax relief for landlords owning buy-to-let properties. Understanding these new laws and the financial impact they have on your property income is critical to navigating the shifting landscape of the UK real estate market. Here, we will delve into the recent changes, how they impact landlords, and how to navigate these changes effectively to secure your rental income and maintain a robust property portfolio.
What changes have been made to the buy-to-let mortgage interest tax relief?
In 2015, the UK government announced a significant change to the way landlords can claim tax relief on their buy-to-let properties’ mortgage interest costs. In the past, landlords could deduct their entire mortgage interest cost from their rental income before calculating their tax liability. The changes, fully phased in by 2020, have replaced this relief with a basic rate tax credit, currently set at 20%. This credit is applied to the amount of mortgage interest paid, not the rental income. This shift has raised the taxable income for many landlords.
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The aim of these changes was to create a level playing field between landlords and homeowners, as homeowners do not receive any tax relief on their mortgage interest. However, this shift has significantly impacted rental business finance, especially for landlords on higher income tax rates, and those with substantial mortgage interest costs.
How does this affect your income as a landlord?
The changes to the buy-to-let mortgage interest tax relief will likely increase your tax bill if you’re a landlord. Before the changes, landlords could claim relief on their interest payments at their marginal rate of tax, whether it was 20%, 40%, or 45%. Now, irrespective of your income tax bracket, you can only claim relief at the basic rate of 20%.
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For landlords who are basic rate taxpayers and do not have a mortgage interest cost exceeding 75% of their rental income, there will be no change. However, if you’re a higher or additional rate taxpayer, you will certainly be impacted. Your tax bill could increase, and you even risk being pushed into a higher tax bracket due to your increased taxable income.
This has two significant implications. First, it may make buy-to-let properties less profitable, especially for those with high mortgage costs. Second, it may deter potential landlords from entering the market, thereby potentially reducing supply in the rental market.
Strategies to deal with these changes
Despite the challenges posed by these changes, landlords can take steps to mitigate their impact. The key is understanding how these changes affect your property business and taking appropriate action.
Refinancing your mortgage
One of the first steps you should consider is refinancing your mortgage. You could potentially lower your mortgage interest expense, thereby reducing the impact of the tax changes. Moreover, you could consider switching to a repayment mortgage instead of an interest-only mortgage. This move would reduce the outstanding principle over time, thereby reducing the interest expense.
Setting up a limited company
Another strategy is to set up a limited company to hold your buy-to-let properties. Corporations pay corporation tax on their profits, and there were no changes to the rules regarding mortgage interest for companies. Therefore, if you hold your properties in a company, you can still deduct the full amount of the mortgage interest before calculating your tax liability. This route can be more complex and may not be suitable for all landlords, but it is worth considering.
Increasing rents
Lastly, you might consider increasing the rent on your properties. It’s not an ideal solution and could potentially lead to a higher turnover of tenants. However, it’s a strategy that could help offset the increased tax expenses.
Changes to other landlord tax reliefs
The changes to the mortgage interest tax relief are not the only tax changes affecting landlords. The wear and tear allowance, which allowed landlords to deduct 10% of their rental income to account for wear and tear on furnished properties, has been replaced by the Replacement Furniture Relief. This change means landlords can now only deduct the actual costs of replacing furnishings, not an automatic percentage.
Moreover, from April 2020, landlords can no longer deduct the cost of their own labor from their rental income to reduce their tax bill. This change will impact landlords who undertake work on their rental properties themselves.
These changes make it even more crucial for landlords to keep thorough records of all property-related expenses. By keeping track of your costs, including mortgage interest payments, repairs, and replacements, you can ensure that you claim all the tax reliefs available to you.
How to adapt your financial plans
With the evolving landscape of the rental market due to the tax changes, landlords must revisit and adapt their financial plans. The key is to evaluate your financial situation and make necessary changes to keep your property business viable and profitable.
Review your financial plans
The first step in navigating these changes is to review your current financial plans. You should consider the changes in your tax liability due to the new rules. If you’re a higher or additional rate taxpayer, you may need to make significant adjustments to your plans due to the increase in your tax bill.
Adjust your investment strategy
The changes in the buy-to-let mortgage interest tax relief and the other tax rules may require you to adjust your investment strategy. With the reduced profitability of rental properties, particularly for those with high mortgage costs, you might need to consider other investment options.
Seek professional advice
It is always prudent to seek professional advice when dealing with complex financial matters. The changes in the tax rules can be confusing, and you may not fully understand their impact on your property business. A tax professional can help you understand these changes and guide you in making the right decisions.
Conclusion
The UK government’s recent changes in the buy-to-let mortgage interest tax relief and other tax rules have significantly impacted landlords and the rental market. The shift from the ability to deduct the full mortgage interest from rental income to a basic rate tax credit has increased the tax liability for many landlords, particularly those in the higher income tax brackets.
While these changes pose challenges, they also present opportunities for landlords to reassess and adapt their financial plans. Strategies such as refinancing your mortgage, setting up a limited company, and increasing rents can help mitigate the impact of these changes.
Furthermore, the changes in other tax reliefs, such as the wear and tear allowance and labor costs, emphasize the importance of keeping thorough records of all property-related expenses. By doing so, landlords can ensure that they claim all the tax reliefs available to them.
In conclusion, navigating these changes requires understanding their impact, making necessary adjustments, and seeking professional advice. While the landscape may seem daunting, with careful planning and strategic decisions, landlords can continue to thrive in the UK rental market.
