Sharing the returns on Buy-To-Let with the tax man

Sharing the returns on Buy-To-Let with the tax man.

Following on from our recent blog on gearing up to purchase property, we thought it would be a good idea to briefly talk about the recent changes to the taxation of buy-to-let (BTL) residential property.

Recent changes to the taxation of BTL residential property has seen the introduction of a restriction on the amount of tax relief investors can claim on finance costs such as mortgage interest. Under the old system, investors were able to claim a full deduction from property income for the cost of mortgage interest, effectively giving tax relief at the investor’s highest marginal rate of income tax. Under the new system, tax relief for finance costs will be restricted to a basic rate tax deduction. These changes are unlikely to affect basic rate taxpayers, however, BTL investors who pay tax at the higher (40%) or additional rate (45%) of income tax could see a significant rise in their tax bill as a result of these changes.

The restriction is being phased in over 4 years, and for the 2019/20 tax year 75% of mortgage interest costs are subject to the basic rate tax restriction, so for example, if an investor’s mortgage interest costs on a buy-to-let property total £4,000, then £3,000 of this would be subject to the restriction with £600 (£3,000 x 20%) claimed as a tax deduction. In 2019/20, the remaining £1,000 can still be claimed as an expense in full and so will benefit from tax relief at the investor’s highest marginal rate of tax. However, from April 2020 the full amount of mortgage interest costs will be subject to the basic rate tax restriction. The table below summarises the effect this could have on a higher rate taxpayer.

Tax Year Tax payable under previous system Tax payable under new system Increase in tax
2019/20 £1,600 £2,440 £840
From April 2020 £1,600 £2,720 £1,120
Figures based on a mortgage interest cost of £5,600 per annum with rental income of £9,600 per annum, for a higher rate taxpayer.

As we have previously mentioned, UK property is a great asset to hold in a diversified investment portfolio and this asset class has historically offered attractive returns, however, for those considering gearing up to purchase a residential Buy-To-Let property in the future, the tax changes discussed above should be carefully considered as they have the potential to significantly affect after tax returns, especially for higher and additional rate tax payers.

If you’d like further information on this or would like to discuss your investment portfolio why not give us a call on 01227 931531

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