Chancellor George Osborne has decreed there’s no going back on the new cuts in tax relief on mortgage interest payments for landlords paying higher rate tax.

According to the draft Finance Act 2015, this is how the calculation will work.

The example takes a landlord earning a £30,000 salary and £35,000 in rents currently offsetting £28,000 in mortgage interest relief as a property business expense.

From April 2016, this relief will be phased out over four years to a tax credit of 20% of mortgage interest paid.

The table below shows how this will change the amount of income tax our landlord pays between the 2016 and 2020 tax years.

Salary and rental income for 2020 have been increased to reflect higher earnings and rents over the intervening period. Mortgage interest stays the same, although rates will inevitably rise before April 2020.

The crucial point is our landlord makes a £7,000 rental profit in 2016 after offsetting mortgage interest.

In 2020, this taxable profit becomes £30,400. The change in tax relief makes our landlord a higher rate taxpayer, and although the mortgage interest tax credit reduces some of the higher rate tax due, income tax is still 75% higher in 2020 than in 2016.

The tax credit is calculated as 20% of the lowest of:

  • Finance costs not subtracted from income – £28,000
  • Property business profits – £38,000
  • Income exceeding allowances – £60,500

Landlords should act now to work out how the tax shock will affect their businesses, as they have four years to plan.

Unfortunately, they can take limited action to counter the tax increase. Options include:

  • Switching buy to let properties into a company – but this triggers capital gains tax and stamp duty
  • Switching buy to lets to holiday lets – only optional in some areas
  • Converting buy to lets to commercial property – again a limited option
  • Selling to a private home buyer – again a capital gains tax trigger

Mortgage Interest Tax Relief – An Example

 

2016-17

2020-21

Income calculation

£

£

£

£

Salary

30000

35000

Rental income

35000

38000

Less mortgage interest relief

-28000

 

0

 
Total income

37000

0

73000

Personal income tax allowance

-11000

-12500

   
Total taxable income

26000

60500

Tax calculation
Basic rate threshold

32000

37500

Tax @ 20%

5200

7500

Tax @ 40%

0

9200

Less mortgage interest tax credit @ 20%

0

-7600

   
Tax due:

5200

9100

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