In the past, landlords were able to deduct the full cost of their mortgage interest payments on their rental properties before they had to pay tax – this is no longer the case. As of April last year, mortgage, overdraft and loan interest costs cannot be taken into consideration when calculating your taxable rental income.
This is due to the amendment know as Section 24 of the Finance Act (No.2), dubbed as ‘The Tenant Tax’. Changing the Generally Accepted Accounting Principles (GAAP), the amendment will change the way that profit is calculated on rental portfolios in the UK. It applies to all UK resident landlords with residential rental properties situated in any country worldwide, any non-UK resident landlords with residential rental properties in the UK, and any trusts or partnerships with a residential rental portfolio.
Who will be most affected?
Those who will feel the impact of the change the most will be landlords with high-loan-to-value portfolios, who currently have a rental yield of 4% or lower. Essentially what the amendment will do, is push certain landlords into a higher tax bracket despite the fact that their income has not changed or increased. If the landlord is already dealing with a marginal rental yield of below 4%, the result could be that the run into a negative cash flow situation and financial distress.
Landlords who have a buy-to-let mortgage in the 40% to 45% tax brackets will pay more tax, while those in the 20% bracket might pay additional tax if their gross income, which is their rental income inclusive of all other revenue streams is higher than £45,000.
It is important to bear in mind that landlords will be reporting an inflated profit on their tax returns, which could impact their eligibility for child benefit, tax credits and increase any student loan payments.
Thankfully the changes will be phased in over a period of four years from 6 April 2017, with the full brunt of the change only fully being felt on 6 April 2020, giving landlords some time to decide whether they wish to remain in the rental game or sell up. By 2020, all finance costs will only be restricted to a 20% tax relief.
What to do next?
Landlords who want to hold onto their rental properties will require cash flow. They will also need to ensure they have a decent buffer so they don’t run into financial difficulty that forces them to sell. Ideally, as the first point of call , speaking to a knowledgeable tax adviser who understands property will be their best bet for successfully navigating the Section 24 road ahead.
For more information regarding Section 24 or ways to reduce the financial impact, contact RE/MAX London at [email protected]