This is not an article about how to get tax relief on your personal mortgage, although there are still legal and ethical ways to do this. What I am talking about here is the mortgage interest relief you can claim if you have any “buy-to-let” property investments.
Up to April 2017 you can reduce your taxable profits from your rental business by offsetting against that profit any interest you pay on mortgages you have taken out to fund that business. Not the capital, of course, so you could still find your rental business produces little or no cash surplus, particularly in its early days when there may be quite a high loan to value. But at least you get some relief from income tax on your rental income by offsetting the mortgage interest.
But from April 2017 the system will begin to change, and by April 2020 it will have changed completely. The change means most landlords will find their rental business is less profitable for them.
What is changing is that interest as a “deductible expense” is being removed, and being replaced by interest as a “tax reducer”. The new rules will allow you to claim the interest as a tax reducer at 20%.
The difference between a deductible expense and a tax reducer is quite simple. If you have a deductible expense, you do what it says on the tin – you deduct that expense from your profit, and therefore there is a lower profit on which you pay income tax. If you have a tax reducer, the profit on which you pay income tax does not change, but once the tax is calculated you then reduce that tax liability by applying the tax reducer.
If you currently have a marginal tax rate higher than 20% you will realize that this change will clearly reduce the tax relief you can claim. If, for example, you are a 40% taxpayer then before April 2017 you can claim tax relief of 40% of the interest you pay. From April 2020 you will only be able to claim 20%. In other words, the relief you get will only be half of what it used to be.
Perhaps, though, you are getting good tax advice and are only a 20% taxpayer. If so, does this mean the changes in mortgage interest relief will not affect you at all? It would seem to be the case, as you get 20% relief now and will continue to get 20% relief when the changes are fully in place. But everything is not as it seems. You may well find you still end up paying more tax under the new system.
Imagine, for example, that you have rental income of £24,000, pay mortgage interest of £12,000, and a salary of £31,000. Take a look at the following table which shows your tax liability in 2016/17 and then in 2020/21:
Even though you are a 20% taxpayer in 2016/17, and even though your income and the interest has not changed at all, in 2020/21 you are a 40% taxpayer, paying an additional £2,400 tax!
The only reason for the increase in tax is because the relief has changed from “deductible expense” to a “tax reducer”.
Finally, you should be aware that the change is coming in stages from 2017 to 2020. In 2017/18 you will be able to deduct 75% of the mortgage interest from your rental profits, and then use a 20% tax reducer on the remaining 25%. In 2017/18 half of the interest will be deductible and half will give you a 20% tax reducer. In 2019/20 you will deduct 25% of the interest from rental profits and use a 20% tax reducer on the remaining 75%. Then in 2020/21 you will no longer be able to deduct any mortgage interest from your profits and will have to apply the 20% tax reducer to all of it.
Be ready for this change. Check whether or not you are likely to pay more tax as a result and make sure you keep enough cash aside for the increase if that is the case. This might also be a good time to review your tax planning and investment strategy. Please contact us if you would like to discuss this further.