Buy-to-let landlords: are you seeing a drop in profits?

Before 2017, buy-to-let landlords were able to enjoy significant tax reliefs by being able to deduct interest payments off their buy-to-let mortgage from profits before paying tax on the remaining profit. This was known as buy-to-let tax relief. This tax relief has been reduced significantly since 2017 and will totally disappear from tax year 2020/2021. Buy-to-let landlords: are you seeing a drop in profits?

For example before 2017, if you made £10,000 a year in rental income and your annual mortgage interest payments over the year amounted to around £9,000, you would only need to pay tax on the remaining £1,000 of rental income.

The amount of tax you would pay depends on what tax bracket you sit in. If you are basic rate tax payer, you would only pay 20% on £1,000 or £200 from your total rental income of £10,000.

This example demonstrates how valuable the buy-to-let tax relief was before 2017, but since then, the government has looked to reduce this tax relief, driven in part to the lack of housing available for first time buyers. As of 2020/21. the buy-to-let tax relief will disappear.

So what has changed since 2017 for buy-to-let landlords?

Since 2017, some buy-to-let landlords have been seeing a steady drop in profits due to annual reduction in the valuable buy-to-let tax relief if they are higher or additional rate tax payers.

But even as a basic rate tax payer, it is important to understand that even though your tax bill has not changed, the tax calculation has, which you will need to understand as the tax relief will disappear from tax year 2020/2021.

Pre-2017, if you received gross profits of £20,000 from your rental property and were a basic rate taxpayer you would historically have taken the £5,000 interest off the £20,000 total income, giving £15,000 of taxable income charged at 20% basic rate and a tax bill of £3,000 for the year.

From this current tax year 2019/20, you can now only claim 25% of mortgage interest payments as tax free whatever tax bracket you fall into, be it basic, higher or additional rate. The remaining 75% of mortgage interest payments enjoys only 20% tax relief. And from 2020/21 there will no 25% tax free element available and all mortgage interest payments will be taxed at 20%.

Basic rate taxpayer example for current tax year 2019/20:

• £20,000 of rental income, of which £5,000 are mortgage interest payments
• Of the £5,000 of mortgage interest payments:
  • 25% is tax free or £1,250
  • Remaining amount of £3,750 receives 20% tax relief of £750
• Of the original £20,000 rental income minus the 25% tax free mortgage interest payment element of £1,250, you have taxable income of £18,750 which is taxed at 20%.
• This gives rise to a tax bill of £3,750
• We must also remember to deduct the additional 20% or £750 tax relief, which gives a final tax liability of £3,000 (£3,750 – £750)

As you can see, the tax bill for both calculations as a basic rate tax payer total the same amount of tax due of £3,000 in our first example, but the current tax calculations clearly show the government looking to reduce this tax relief over time. Indeed, from tax year 2020/21, in this example, the full rental income will be taxed at 20% with no buy-to-let tax relief available, and the bill would rise to £4,000 if the same rental income is earned.

What if I am higher or additional rate buy-to-let landlord?

Whereas basic rate taxpayers will not be affected by the changing of tax rules around buy-to-let tax relief for another year, higher and additional rate buy-to-let landlords are seeing their tax bills rise significantly from now, from the current 2019/20 tax year.

Using the same example above, but if you were a higher or additional rate taxpayer:

• £20,000 of rental income, of which £5,000 are mortgage interest payments
• Of the £5,000 of mortgage interest payments:
  • 25% is tax free or £1,250
  • Remaining amount of £3,750 receives 20% tax relief of £750
• Of the original £20,000 rental income minus the 25% tax free mortgage interest payment element of £1,250, you have taxable income of £18,750 which is taxed at 40% as a higher rate tax payer or 45% as an additional rate tax payer
• This is in contrast to pre-2017 tax rules, where only £15,000 would be taxed at 40% or 45% (full rental income of £20,000 minus the £5,000 mortgage interest payments)
• A higher rate taxpayer will see their tax bill rise from £6,000 to £7,5000 or a 20% increase
• An additional rate taxpayer will see their tax bill rise from £6,750 to £8,437.50 with also a 20% increase

From the next year tax year 2020/21, with the complete removal of buy-to-let tax relief, buy-to-let landlords who are higher or additional rate taxpayers will see their profits drop by 25%, and many landlords will find their position as landlords as untenable.

Indeed, this is what the government is looking to do: forcing landlords to sell up to those people looking to buy their first home or their main residence, which would otherwise not be available.

Are you directly affected by these changes? Please get in touch to see how we can help.

Written by Shaima Todd.