It is rather ironic that buy to let investors in the UK seem to have been targeted by the government because of a buoyant property market brought on by government inaction. Momentum has been growing in the private rental market for some time now with UK government well behind new build targets and a significant lack of social housing. So, in order to “rebalance” the situation the UK government has made a significant change to mortgage relief for buy to let investors.
Old style mortgage tax relief
Prior to 2017 buy to let investors were able to offset all of their mortgage interest charges against rental income. Where for example annual rental income was £20,000 and annual mortgage interest was £18,000, this left a net income of £2000. Investors simply paid tax on the £2000 at their underlying rate. However, the situation has changed dramatically.
New style mortgage tax relief
New style mortgage tax relief was subtly introduced in the 2017/18 tax year reducing the amount of mortgage interest which could be deducted from rental income down to 75%. The situation was balanced, on the surface at least, by introducing a new 20% tax credit. The 25% of annual mortgage interest that could not be offset against rental income now qualifies for a new 20% tax credit. There will be further changes in future tax years:
• 2018/19 will see 50% of mortgage interest offset against rental income and 50% qualifying for the 20% tax credit
• 2019/20 will see 25% of mortgage interest offset against rental income and 75% qualifying for the 20% tax credit
• 2020/21 will eliminate mortgage interest offset against rental income with all mortgage interest qualifying for the 20% tax credit
This is all good and well for basic rate taxpayers who have buy to let investments but it will significantly reduce the net income of higher rate taxpayers.
Simple calculation for higher rate taxpayers
Using the example above, under the old system a higher rate taxpayer would be able to deduct £18,000 in mortgage interest from their £20,000 rental income. They would pay 40% on the £2000 net income which equates to a tax charge of £800. Under the new system, it is very different:
• Rental income £20,000
• 40% tax on £20,000 equates to £8000
In theory £8000 is the tax charge for a 40% taxpayer but this is partly offset using the 20% tax credit against the £18,000 of mortgage interest (£3600). So, a 40% taxpayer will be able to deduct £3600 from their £8000 initial tax charge equating to a net tax charge of £4400. This compares to just £800 under the old mortgage interest relief system.
Using a limited company
There is a loophole in the buy to let regulations covering mortgage interest relief. If all of your buy to let investments are held within a limited company, or similar type of vehicle, then mortgage interest can still be offset against income. There will obviously be additional charges in creating and managing a limited company to acquire buy to let assets. However, for those higher rate taxpayers with relatively large portfolios there could be some significant savings.
It is highly unlikely that the UK authorities will attempt to change the way in which costs are offset within a limited company even for buy to let investments. This would set a precedent the likes of which have never been seen before in company law. Therefore, it is worth taking professional advice if you plan on building up a significant buy to let investment portfolio and you are concerned about your tax situation.