How do the tax changes affect buy-to-let properties?
The Government’s Budget in July 2015 included changes to the way in which tax relief is calculated for landlords. These changes will be phased over the next few years and could have a significant impact on your income as a landlord, so it’s important that you’re aware of what’s changing and when.
Current Regulations
At the moment landlords pay income tax on profits gained from the buy-to-let property. For example, imagine your rental income is £10,000 per year and your mortgage payments total an amount of £9,000. This means that you would only pay tax on £1,000, which is the difference between the mortgage payments and the income from the rent. Landlords who pay the basic rate of tax (20%) will pay £200 tax and those paying the higher rate (40%) will pay £400. For simplicity, this example assumes there aren’t any other deductible expenses for tax purposes.
New Regulations
Under the new regulations, which will be introduced gradually over a three year period from April 2017, tax will be payable on the rental income as a whole. From 2020/2021, when the new rules have fully come into effect, landlords will only be able to deduct a tax free amount of 20% of the mortgage payments.
Going back to our earlier example, in 2020 when the phasing of the new rules has been completed and are fully in effect, landlords will be taxed 20% of the £10,000 rental income (£2,000), then 20% of the £9,000 mortgage payments (£1,800) can be deducted. This means that for landlords paying 20% tax, there won’t be any change in the amount paid in tax.
However, higher rate taxpayers will see an increase in the amount of tax they pay. Based on the same example, in 2020 they will be taxed at 40% of £10,000 (£4,000), but will only be able to deduct 20% of their £9,000 mortgage payments the same as basic rate taxpayers. This means that the amount paid by high rate taxpayers is £2,200, compared with £400 under the previous rules.
Wear and Tear Allowances
It’s also been proposed that changes will be made to the way in which ‘wear and tear’ deductions will be calculated. From April 2016 the formal Wear and Tear Allowance (which allows 10% of profit from rental income to be written off for wear and tear) will be replaced with an allowance for landlords to deduct the costs which they actually incur for replacing furnishings.
It’s important to note that although the old scheme only applied to fully furnished properties, the new relief will apply to landlords of all residential properties whether they are furnished or not.