Many landlords will see taxes increase and profits decrease as a result of the summer budget, with the chancellor announcing plans to remove mortgage interest relief.
Under current rules, mortgage interest is an allowable expense for landlords. When calculating taxable income, landlords deduct costs including mortgage interest relief from rental income.
Under the new regime, expenses such as repairs and estate agent fees will still be allowable expenses, but higher rate tax payers’ entitlement to mortgage interest relief will be significantly reduced.
How do the changes to mortgage interest relief work?
Let’s assume a higher rate tax payer buys a property for £550k with a 75% mortgage and 3.5% interest rate. They rent out the property for £425 per week.
This landlord has seen net proceeds fall substantially from £4,020 to £1,140.
Not all bad news
There are some mitigating factors and most landlords will not suffer as much as the example above.
Landlords who pay basic rate tax (earnings under £40k) will see no change in their net proceeds. The new tax relief system will entirely offset the change in treatment of mortgage interest.
Over the past decade, especially in London, many landlords have experienced significant capital and rental price growth. As a result, interest payments often represent a smaller percentage of income than the example above. The change in tax rules has a lesser impact on landlords with smaller mortgage costs.
Finally, the new rules will be phased in over a period of four years. Starting from the 2017/18 tax year, the impact will kick in and increase year on year until 2020/21, at which point it will be fully implemented.