Buy-to-let contractors, are you ready for the end of mortgage interest relief?
Many contractors see property as a viable supplement, or even an alternative, to setting up pensions. And rightly so, writes Taj Kang, compliance director of CMME.
However, the reality is that profit from mortgaged buy-to-let property has been steadily eroded since April 2017 due to tax changes introduced by HMRC. From April this year, the phased removal of mortgage interest as a fully deductible expense will be in full effect.
The old and new: the rules on mortgage interest tax relief
Previously, and until now, landlords (and that includes any contractors trying their hand at buy-to-let investing), could deduct the annual interest payments towards the mortgages on their rented properties to reduce the amount of income tax they paid against the rental income.
But from April 6th 2020,you will no longer be able to deduct any mortgage-related expenses from the income. Instead, landlords will receive a tax credit that is based on 20% (higher-rate taxpayers) or 40% (basic rate taxpayers), of the mortgage interest.
The tax credit is given as a reduction in tax liability instead of a reduction to taxable income, meaning landlords will have to declare all of their rental income, pay income tax on the full amount, and then claim back 20% of this as credit, or 40% for those who receive the highest rate.
No cliff-edge, but no more mortgage expenses deductions from rental income either
Somewhat considerately, the government has phased in the changes to avoid a ‘cliff-edge’ which would have forced sales of swathes of buy-to-let property, potentially leaving many tenants homeless and exacerbating the need for housing.
During the phase-in, the amount of mortgage interest that landlords have been able to deduct has reduced by 25% every year, as outlined in the table below.
| Tax Year | Percentage of mortgage interest payments deductible from rental income | Percentage of mortgage interest payments qualifying for the new 20% tax credit |
|---|---|---|
| Before April 2017 | 100% | 0% |
| 2017-2018 | 75% | 25% |
| 2018-2019 | 50% | 50% |
| 2019-2020 | 25% | 75% |
| After April 2020 | 0% | 100% |
The main issue for contractors is that many will obviously add to their tax bill via the standalone assessment of the property profit, given the removal of the largest allowable expense. Two additional issues that may arise from this increased income are:
- the increased income could trip many over into the higher rate income tax bracket;
- the above, outlined in i), could reduce or completely remove entitlement to Child Benefit.
Where a limited company comes into its own for buy-to-let
The impact of these could be serious for some households. Yet there is a potential way out. The solution some are utilising is to set up a corporate vehicle – a limited company for example, to hold and manage the rented residential property that they own. This is effective because removal of the tax relief doesn’t apply to property owned by a limited company, and all expenses can be written off for tax -- much in the same way as a contractor’s limited company can write off expenses.
Then, landlords can draw the profit from the company that owns the property by way of a dividend, on which they pay the tax. Here, we would recommend the services of a good accountant, qualified to advise on tax and with the experience to know the best way to access the profit in the company.
As well as a tax adviser, consider the services of a qualified IFA if the property you hold is for income in retirement. Pensions are becoming more and more popular for those who previously thought that property was the safe, risk-free bet for retirement income. Currently, we’d say that all avenues should be thoroughly explored yet ideally, and to reduce the instances of any nasty surprises later down the line, via the right professional advice.
Accountant? IFA? Good. But don’t forget the broker
If you take such advice, and buy-to-let via a corporate vehicle is recommended, that is the best time to seek out a good mortgage broker who understands buy-to-let and contractors’ requirements. With the right broker, your bread-and-butter contract earnings through your limited company play a part in the overall mortgage eligibility assessment for your investment properties.
Of course, since the tax changes have been phased in over the last three years, buying new buy-to-let property via a limited company has become the preferred route for shrewd landlords. But the issue for a considerable number of such investors is that all the current calculations are based on the tax-free personal allowance remaining static until 2020. We have seen the current government mention increasing the higher rate tax bracket from £50,000 to £80,000, although these plans appear to have been shelved for the time being. That said, even a small increase to the higher rate tax bracket could have a positive impact for contractors who are part-time landlords and, more specifically, a positive impact on their tax bills from let property. So contractors have good reason to watch Budget 2020 with interest, even if they won’t see the impact of this year’s tax relief removal until their 2022 tax returns are submitted.
Taxing times…call for a different strategy
It is inevitable that your tax bill will increase if you’re a full-time contractor and a part-time landlord who owns a mortgaged property. It is therefore important to really understand all of the expenses that you can offset aside from mortgage interest, and ensure these are tracked and claimed for. For many, at least there is some good news on the horizon about a more active property market this year, so there’s always the option to sell and look at a different investment strategy.
