Becoming a buy to let landlord

Ideally the government wants more home owners but with house prices so high it’s very difficult for first time buyers to get on to the property ladder.  Instead was has happened over the past 30 years is that homeowners with higher incomes have bought more properties to rent out as an alternative to a pension making it even more likely for potential first-time buyers to continue to rent.  In an attempt to buck this trend, the government has brought in legislation that makes it considerably less lucrative to own multiple homes and rent them out.  The 10% wear and tear allowance was scrapped, CGT has increased, extra stamp duty added and mortgages regulations are continuously being tightened but the most significant change in recent years has been the phasing out of mortgage interest relief.

 

Mortgage Interest Relief (MIR)

Historically a buy to let landlord would add their rental income to their tax return and then subtract the costs associated with letting the property like repairs, insurance or estate agent’s fees but the biggest expense was usually the mortgage payments.  Between April 2017 and April 2020, the interest portion of the mortgage payment will be gradually phased out as a legitimate expense (effectively increasing the profit and potentially the tax bill).

  • In 2017/18, 75% of finance costs are an allowable expense, with the remaining 25% being available as a basic rate tax reduction;
  • In 2018/19, 50% of finance costs are an allowable expense, with the remaining 50% given as a basic rate tax reduction;
  • In 2019/20, 25% of finance costs are an allowable expense, with the remaining 75% given as a basic rate tax reduction;
  • From 2020 to 2021 all financing costs incurred by a landlord will be given as a basic rate tax reduction.

This means that higher rate tax payers with rental income are likely to see significant increases in their tax bill because they’ll only get basic rate relief. So, for example, if someone has £20k of rental income with £10k of mortgage interest and £5k of other expenses, they would have made £5k profit in the old system.  In 2020 however, the profit is £15k and while they would get £10k of basic rate tax relief, a higher rate tax payer will still end up paying an extra £2k in tax despite making the same amount of money.  This effect is shown below:

Year Income Expenses Profit 40% Tax Tax relief Tax bill Extra tax
16/17 £20k £15k £5k £2k £0 £2k £0
17/18 £20k £12.5k £7.5k £3k £500 £2.5k £500
18/19 £20k £10k £10k £4k £1k £3k £1k
19/20 £20k £7.5k £12.5k £5k £1.5k £3.5k £1.5k
20/21 £20k £5k £15k £6k £2k £4k £2k

*assuming income, mortgage interest and other expenses stay constant at £20k, £10k and £5k respectively

It’s also worth noting that basic rate tax payers are not unaffected by the changes as their taxable income will increase as a result of the changes, often pushing them into higher rate tax without their income increasing.