The 2020/21 tax year is the first in which no mortgage interest will be allowed against property income profits, having been gradually withdrawn over the last few years. There are other changes also affecting mainly landlords – changes to capital gains tax and reporting being the most notable. And with Making Tax Digital for Income Tax only two years away, there will be yet more changes for landlords to contend with.
Interest, loan costs and other charges
If you are a landlord with a mortgage (or many mortgages…) you may be aware that the amount of mortgage interest costs allowable as deductions against your property income profit has been reducing over the last few years. Mortgage and loan interest (and other finance costs) will no longer be deductible from profits at all in the 2020/21 tax year – instead landlords will be given a tax reduction equal to 20% of the finance costs (in most cases).
So what does this mean in practice?
Using some numbers to illustrate, if Jane had property income of £10,000, on which she paid mortgage interest of £7,000, she may well believe that her profits (ignoring any other expenses) were £3,000. However for tax purposes her profit (in 2020/21) would be £10,000 – she would then be given a tax reduction of £7,000 at 20% (£1,400).
If Jane is a basic rate taxpayer (and comfortably within the basic rate) this will make no difference to her. Under the old system she would pay tax of 20% on her profits of £3,000, giving her a tax bill of £600. Under the new system she would be taxed at 20% on £10,000 (£2,000), and then have the £1,400 tax reducer deducted from this, leaving tax to pay of £600.
But what if Jane is a higher rate taxpayer? Or even worse, has 10 rental properties, all with large mortgages?
Consider Janet, who personally owns 13 properties, all with annual income of £10,000 and mortgage interest of £7,000. Under the old system for calculating rental profits, her annual income (assuming it all came from the rental properties) would have been £39,000, comfortably within the basic rate tax band. Her total annual tax bill, if this system was still in place today, would be £5,300.
Under the new system, her rental profits have swelled to £130,000. This sadly not only pushes most of her income into the higher rate tax bracket, but also means that she is no longer entitled to a personal tax allowance (as this is gradually withdrawn for those with income of over £100K). Her tax bill has become a whopping £26,300 per year, almost 5 times her previous bill.
What are the alternatives?
New landlords intending to build a portfolio of multiple properties should consider putting these into a limited company rather than owning them personally. This option is not suitable for everyone, and professional advice should be sought before entering into such an arrangement, however this structure would enable the full amount of mortgage interest to be deducted from profits.
Holiday lets are also exempt from these restrictions, and so this may provide an alternative for the prospective landlord, or a potential lifeline to existing landlords. In order to qualify as a holiday let there annual limits which must be met (on the number of days let and available to let), which landlords should familiarise themselves with before embarking on this route.
If existing landlords want to put their properties into a limited company, they will potentially incur both a capital gains tax charge and stamp duty costs. This is therefore unlikely to be suitable for most landlords, however there may be some for whom this is a viable option.
Residential Property Capital Gains Tax Return
The next tax development to hit landlords was the introduction of the Residential Property Capital Gains Tax Return in 2020. This is one of the most significant tax changes in recent years, and means that residential properties sold which are subject to Capital Gains Tax (usually second homes or rental properties where the taxable gain exceeds £12,300) now have to be reported to HMRC, and the tax on the gain paid over, within 30 days of completion.
This not only represents a logistical challenge, but means that tax on property sales now needs to be paid up to 20 months earlier than under the previous system.
Again, this change only affects individuals – property letting companies will continue to report gains and pay tax through their corporation tax returns within the usual timeframe.
Other Capital Gains Tax Changes
2020 also saw the removal of lettings relief in all but a tiny number of cases (where the landlord has lodgers, rather than renting out the entire property). Lettings relief gave capital gains tax relief where the landlord had once lived in the property as his or her only or main residence, and was in many cases a very generous relief, often completely extinguishing any tax charge on the sale of the property. Thus landlords renting out a property that they once lived in will face a higher tax charge when they come to sell, although they will still be entitled to Principal Private Residence Relief for the years that they lived in the property.
Making Tax Digital for Income Tax
Those in business may have heard of ‘Making Tax Digital’ for VAT, however that was only the beginning of the story. This next phase of Making Tax Digital is due to come in in 2023, and will require landlords and the self employed with property / self employment income above £10,000 to keep their business records digitally and file quarterly income and expenses ‘updates’. This represents possibly the biggest change to the tax system since the introduction of self assessment, and is only 2 years away. Watch this space…