Date posted: 29th Oct 2018
As you are probably aware, there are significant tax changes in relation to the tax relief available for finance costs (such as mortgage interest) particularly for those already earning income in excess of the higher rate threshold (currently c£46,000).
If you aren’t aware of these changes, our article avoid the increases in tax bills may help you understand these issues.
However, it’s worth pointing out that the changes in the relief, can actually seriously impact upon basic rate taxpayers.
Example – basic rate to higher rate
For instance, take Milly, who has a job with a legal firm earning £41,000 (so below the higher rate threshold). Milly also earns £12,000 in rental income from letting her old home, after she moved in with her boyfriend. Ignoring other costs, Milly pays £8,000 in mortgage interest each year. Before the phased introduction of the new rules, Milly could deduct the full £8,000 from her £12,000 income, leaving her with £4,000 rental profit, on which she paid 20% tax i.e. £800 as her total income of £45,000 was still below the higher rate threshold.
However, once the rules are fully phased in, Milly will have an income of £53,000 (£41,000 + £12,000). This would mean that £5,000 (£46,000 – £41,000) of the rental income would be taxed at basic rate with the other £7,000 of rental income taxed at 40%. Relief for the mortgage interest is given via a 20% tax credit.
Milly’s tax bill (on the rental activities) would then be – (£5,000 x 20%) + (£7,000 x 40%) – (£8,000 x 20%) = £2,200 – nearly treble what it was previously! Milly may be completely unaware of this as she may think she isn’t a higher rate taxpayer. However, as a result of the changes, she has inadvertently become a higher rate taxpayer.
The impact could be even greater – as you may be aware, child benefit is not due in full for those that earn between £50,000 and £60,000. In fact, those earning over £60,000 have to repay all of the child benefit paid.
Example – child benefit impact
To highlight this, lets say Joey earns £35,000 from his job but has historically invested in rental properties which generate income of £25,000 per annum. The properties all have buy to let mortgages and the mortgage interest each year is £20,000, leaving Joey with a £5,000 profit. Prior to the introduction of the new rules, Joey’s tax liability would have been £1,000 (£5,000 x 20%) but now this is £3,800 ((£11,000 x 20%) + (£14,000 x 40%) – (£20,000 x 20%)). In addition, Joey’s income for tax purposes is deemed to be £60,000, so the child benefit that he receives for his two children of c£1,800 is also repayable to HMRC. Unknowingly Joey has gone from a tax bill of £1,000 to a tax bill of £5,600.
As you can see, we have highlighted some of the issues that landlords will face. As income levels increase, those that earn at higher rates may be impacted further by withdrawals of personal allowance once income (ignoring the mortgage interest) goes above £100,000 and similarly restrictions on pensions savings allowances once income goes above £150,000.
We believe that the cut to mortgage interest relief is overlooked issue by many landlords and would urge those landlords affected by these changes to give us a call.