Further pain for buy-to-let landlords

There has been much in the press about the clamp down by HMRC on buy to let landlords by way of the increase in the rates of Stamp Duty Land Tax when additional residential properties are purchased and the forthcoming restriction on loan interest relief to the basic rate of income tax only.  But is that the end of the story?

We know that the restriction will be phased in between 2017/2018 and 2020/2021 such that, from 2020/2021, all financing costs incurred by a landlord will be given as a basic rate tax deduction but, as ever, the devil is in the detail!

There’s potentially more pain to come when we look at the way in which the reduction is to be calculated.  This is because the potential relief can be further restricted according to the individual’s “adjusted total income”.

Adjusted total income is the individual’s net income for the year with the exception of savings and dividend income and reduced by the personal allowance.

Example 1

HMRC give the following example of how the maximum relief is calculated each year and how any unrelieved amounts can be carried forward:

In the tax year 2020 to 2021 Brian’s annual salary before tax is £36,000 and his rental income is £20,000. The property was empty for 2 months while he found a new tenant and during that time he carried out some repairs on the property.

Brian’s mortgage interest was £15,000 and he had other allowable expenses of £7,000 due to the repairs he carried out.

Tax year 2020 to 2021

Salary before tax =                                                                                      £36,000

Property income calculation:

Rental income =                                                       £20,000

Allowable non-finance costs =                               – £7,000

Property profits =                                                                                         £13,000

Total income =                                                                                               £49,000

Brian’s tax reduction is calculated as 20% of the lower of:

• finance costs = £15,000
• property profits = £13,000
• adjusted total income (exceeding personal allowance) = £38,000

The lowest figure is property profits, so £13,000 x 20% = £2,600 tax reduction.
The £2,000 finance costs (£15,000 – £13,000) that haven’t been used to calculate his basic rate tax reduction are carried forward to calculate his basic rate tax reduction in the following year.

Example 2

In the tax year 2021 to 2022, Brian’s salary is still £36,000 and his rental income is £24,000. His mortgage interest is still £15,000 and he has other allowable expenses of £2,000.

Tax year 2021 to 2022

Salary before tax =                                                                                      £36,000

Property income calculation:

Rental income =                                                       £24,000

Allowable non-finance costs =                              – £2,000

Property profits =                                                                                         £22,000

Total income =                                                                                               £58,000

Brian’s tax reduction is calculated as 20% of the lower of:

• finance costs (£15,000 of the current year and £2,000 brought forward) = £17,000
• property profits = £22,000
• adjusted total income (exceeding personal allowance) = £47,000

The lowest amount this year is finance costs, so £17,000 x 20% = £3,400 tax reduction.

Restriction for Adjusted Total Income

Example 3

This is all well and good but consider the situation (not uncommon for shareholders in private companies) whereby, instead of the above figures, Brian has dividend income of £36,000 in 2021/2022.  His rental income is £24,000. His mortgage interest is still £15,000 and he has other allowable expenses of £2,000.

Tax year 2021 to 2022

Dividend income =                                                                                      £36,000

Property income calculation:

Rental income =                                                       £24,000

Allowable non-finance costs =                              – £2,000

Property profits =                                                                                         £22,000

Total income =                                                                                               £58,000

Brian’s tax reduction is calculated as 20% of the lower of:

• finance costs (£15,000 of the current year and £2,000 brought forward) = £17,000
• property profits = £22,000
• adjusted total income (exceeding personal allowance) = £11,000

The lowest amount this year is adjusted net income, so £11,000 x 20% = £2,200 tax reduction.

So this example shows that by changing the £36,000 salary to dividend income, the tax reduction is restricted by £1,200.

The unused element can still be carried forward but it will take longer to obtain full relief and, depending upon circumstances, it may be that the unused amounts accumulate year on year and are never fully relieved.

Of course, there are planning opportunities to improve the position.  If you are affected by the new rules and want to find out more, contact our tax team on 01522 531341 or email action@wrightvigar.co.uk – they would be delighted to help you.