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Bad News For Landlords!

Shared from Tax Insider: Bad News For Landlords!
By James Bailey, August 2015
James Bailey gives an overview of an important future change announced in the Chancellor’s Budget on 8 July 2015.

A radical change was announced in the Chancellor’s Budget on 8 July 2015, in respect of how landlords of residential property will get relief for interest in future. 

The new rules apply to individuals and partnerships, not to limited companies, and they do not apply to the letting of furnished holiday accommodation or commercial property. According to the Tax Information and Impact Note published on Budget day, this is ‘to make the tax system fairer’.

Restricted interest relief
From April 2017, the tax deduction for interest paid by landlords of residential properties will be reduced. The change will be phased in over a four year period, so that by the tax year 2020/21 the reduced deduction will be in full force.

The change involves replacing the deduction of interest as a business expense with a simple reduction in tax, but limited to the basic rate of income tax – currently 20%. A landlord paying income tax at 40% will thus see the relief from tax on account of interest paid reduce by half over a four year period.

The phased reduction will work like this:

2017/18 – 75% of interest deducted from profit, 25% as a reduction of tax at the basic rate
2018/19 – 50% of interest deducted from profit, 50% as a reduction of tax at the basic rate
2019/20 – 25% of interest deducted from profit, 75% as a reduction of tax at the basic rate.

Case study – residential portfolio
Imagine a landlord with a portfolio of residential properties who pays loan interest of £20,000 a year on his property loans, and pays income tax at 40%:
 

Tax year

Interest paid

Reduction in taxable profit

Reduction in tax

Basic rate credit

Total reduction in tax

2016/17

20,000

20,000

8,000

N/A

8,000

2017/18

20,000

15,000

6,000

1,000

7,000

2018/19

20,000

10,000

4,000

2,000

6,000

2019/20

20,000

 5,000

2,000

3,000

5,000

2020/21

20,000

Nil

Nil

4,000

4,000

 

In other words, the tax relief on the interest paid has been halved. 

In the case of a landlord making losses, unused basic rate tax credit can be carried forward to the next tax year, but not any losses arising from deducting interest from profit.

The new rules will not affect landlords who only pay basic rate tax in the first place, but they will impact particularly hard on those landlords who are heavily borrowed and are looking for capital growth rather than rental profits as their real reward.

So what is to be done? 
The good news is that we have almost two years to plan how to deal with this threat. The first step is to do a calculation of what your tax for 2014/15 would have been if the 2020/21 rules had applied, and then to decide if the rental business can withstand the shock. If not, some means must be found to reduce borrowings, or perhaps to move from ordinary residential letting to either commercial property or furnished holiday accommodation.

The problem for many landlords is that it may not be simple to sell one or more properties to reduce borrowings. There is the classic ‘tax trap’ whereby selling a property is impossible because after repaying the borrowings secured on the property, there is insufficient left to pay the capital gains tax arising from the sale.

There will no doubt be other knock-on effects – lenders will need to factor in the limited deduction for interest when deciding if a landlord will be able to service the loan he is asking for. If many landlords get out of the buy-to-let market, that could affect house prices. The list goes on.

Practical Tip:
There is no simple planning suggestion to be drawn. The important thing is to recognise that these changes are coming (assuming they are enacted in the Finance Act), and to start dealing with their results now.
James Bailey gives an overview of an important future change announced in the Chancellor’s Budget on 8 July 2015.

A radical change was announced in the Chancellor’s Budget on 8 July 2015, in respect of how landlords of residential property will get relief for interest in future. 

The new rules apply to individuals and partnerships, not to limited companies, and they do not apply to the letting of furnished holiday accommodation or commercial property. According to the Tax Information and Impact Note published on Budget day, this is ‘to make the tax system fairer’.

Restricted interest relief
From April 2017, the tax deduction for interest paid by landlords of residential properties will be reduced. The change will be phased in over a four year period, so that by the tax year 2020/21 the reduced deduction will be in full force.

The
... Shared from Tax Insider: Bad News For Landlords!