The Chancellor’s recent announcement in the Autumn Statement regarding a rise in the amount of SDLT payable by landlords and second home owners has received much attention in the media. However, last summer’s Budget contained another key announcement that landlords need to be aware of.
Currently, buy-to-let landlords can deduct their costs (including mortgage interest) from their profits before they pay income tax. Landlords paying income tax at the higher or additional rate receive tax relief at 40% or 45%.
However, in the Budget on 8 July 2015, the government announced that it would restrict the relief on finance costs that individual landlords of residential property are entitled to, to the basic rate of income tax (20%). Accordingly, individual landlords will not be treated differently based on their status as tax payers and the rate of income tax that they pay. The new restriction was passed as part of Finance (No. 2) Act 2015 and will be phased in over four years, starting from 6 April 2017, with the permitted deduction from profits being 75% of the interest charge for 2017-18, 50% for 2018-19, 25% for 2019-20 and 0% thereafter. In each of those years, the percentage of the interest not deducted will be given as a basic rate tax deduction. The restriction will not apply to the interest relating to properties that qualify as furnished holiday lettings.
Mortgage Interest Relief was withdrawn from homeowners 15 years ago. However, landlords still receive the relief. The government’s concern was that the current tax system supports landlords over and above ordinary homeowners and puts buy to let investors at an advantage.
The move came as the Bank of England expressed concern that the rapid growth of buy-to-let mortgages could pose a risk to the UK’s financial stability. In its Financial Stability Report published earlier this month, the Bank stated that it would closely monitor the sector’s activity following the cut to tax relief announced by the Chancellor.
The government will also reform how landlords of residential property can account for the costs they incur in improving and maintaining rental property. As things presently stand, landlords can deduct 10% of their rent from their profit to account for wear and tear, irrespective of whether or not any maintenance or improvements have actually been carried out. This means that landlords can automatically reduce their tax liability even when they have not incurred any costs maintaining or improving the property. From April 2016, however, the government will replace this allowance with a new system that enables all landlords of residential property to only deduct costs they actually incur.
Landlords concerned about this change will need to review their investment strategies to ascertain how it will impact on them from a tax and profit perspective.