Question on BTL mortgage relief

marcusjames

I think I understand the policy change regarding relief on mortgage interest on BTLs, but I'm confused about how this falls within income tax brackets.


Does the 20% relief get applied prior to calculating a pre-tax profit? In some examples it appears to show that tax is calculated and then 20% is added back. This would make a difference when the profit figure pushing income about the marginal higher tax bracket.


Thanks

martinsurrey

marcusjames wrote: »

I think I understand the policy change regarding relief on mortgage interest on BTLs, but I'm confused about how this falls within income tax brackets.


Does the 20% relief get applied prior to calculating a pre-tax profit? In some examples it appears to show that tax is calculated and then 20% is added back. This would make a difference when the profit figure pushing income about the marginal higher tax bracket.


Thanks

you work out the income and tax due and THEN take out mortgage interest relief from your tax bill.

In effect it pushes you up tax bands.


Example

property tycoon A has rental income of £200k with mortgage interest payments of £160k

net income £40k

old system

net income £40k

income tax due = income tax paid = £5698 (FY17/18)

net profit after tax £34,302

new system

Income liable to tax £200k

income tax liability = £75,800
less mortgage interest relief = £32,000
tax paid = £43,800

net LOSS after tax = -£3,800

00ec25

have you read the explanation and examples provided?

https://www.gov.uk/guidance/changes-to-tax-relief-for-residential-landlords-how-its-worked-out-including-case-studies

ignoring the transition period up to 20/21 for the sake of simplicity, the final position is that the interest is ignored when working out the taxable profit. That profit is then added to your other income to give the total taxable figure on which you will be assessed for what tax band you fall in. You will then calculate the tax due on that, and from that tax figure the tax relief is deducted as 20% of the interest charge.

as explained in the guide above, for a basic rate taxpayer that means the end result is the same, no increase to tax paid. However, for those close to the higher rate threshold they will be pushed into it because their taxable income is higher and thus end up paying more tax as they will only get relief at 20%

Pennywise

00ec25 wrote: »

as explained in the guide above, for a basic rate taxpayer that means the end result is the same, no increase to tax paid. however, for those close to the higher rate threshold they will be pushed into it and thus end up paying more tax

Yes, the new rules mean your "income" is now far higher which may impact increased student loan repayments, loss of benefits, liability for repaying child benefit if "gross" income over £50k, liable for loss of personal allowance if taxable income over £100k, etc. Quite nasty when you follow through the figures as to the potential implications.

Cotta

martinsurrey wrote: »

you work out the income and tax due and THEN take out mortgage interest relief from your tax bill.

In effect it pushes you up tax bands.


Example

property tycoon A has rental income of £200k with mortgage interest payments of £160k

net income £40k

old system

net income £40k

income tax due = income tax paid = £5698 (FY17/18)

net profit after tax £34,302

new system

Income liable to tax £200k

income tax liability = £75,800
less mortgage interest relief = £32,000
tax paid = £43,800

net LOSS after tax = -£3,800

So effectively you can never make a profit on a buy to let property?

00ec25

Cotta wrote: »

So effectively you can never make a profit on a buy to let property?

you are sort of right, if you are VERY highly geared it is, as you say, hard to make a net profit since you are paying out a lot of interest without getting tax relief on it. If you have low gearing it may or may not result in little or no profit, depends on your figures!

that is precisely the objective behind the tax change, it forces people who were relying on ever expanding BTL portfolios funded on debt to revise their ways

martinsurrey

Cotta wrote: »

So effectively you can never make a profit on a buy to let property?

You can, but its much harder, as a sole trader, on any sort of scale.

but say for example you own 4 properties renting out for £900 a month, no other income, this tax change will have zero effect on you regardless of gearing as your new "income" of £43.2k is still below the higher rate tax threshold.

the higher the gearing and the higher the income the harder it gets.

Trade as a LTD company and its still just as easy on any scale.

00ec25 wrote: »

that is precisely the objective behind the tax change, it forces people who were relying on ever expanding BTL portfolios funded on debt to revise their ways

yup, start trading as a LTD!

Brighty

I have a very low gearing and it has no effect on me whatsoever at the moment. It pushes me slightly nearer the higher tax threshold, but not over it. So it is possible to make a profit on BTL, you just need to own the property yourself, rather than the bank

00ec25

martinsurrey wrote: »

yup, start trading as a LTD!

indeed, but preferably not using property you already own which the company must therefore buy from you, gets rather taxing doing that

Pennywise

martinsurrey wrote: »

yup, start trading as a LTD!

But you can't get the same level of borrowings and will have higher interest costs as you'll need a commercial loan/mortgage rather than a far cheaper/easier BTL loan.

So, you'd have lower gearing by default, i.e. you'd never get anywhere near 90% LTV with a company loan - probably more like 60%/75% if you're lucky. You'd also have higher arrangement fees and higher interest rates. So, yes, you get better tax relief, but you also have higher costs!

Not to mention higher "exit" taxes, i.e. full corporation tax on profit when you sell each property, no lower 10% CGT rate, no personal annual CGT exemption, no scope for main residence relief nor lettings relief if you live it in for part of your ownership period. Then you have double tax when you eventually close down the company and are taxed upon removing the funds from the company.

So, when you do the sums, it's not quite as simple and isn't really a valid comparison.

Cotta

Interesting discussion, I suspect many BTL LLs will now just sell up.