For landlords, the total tax liability will in some cases be higher, depending on the amount of income generated. The following tables were provided by mortgage broker Mortgages for Business, and serve to show the situation after full implementation of the new rules that limit interest rate relief to the basic rate of tax. The tables assume a personal tax allowance of £12,000 and the basic-rate tax band of £38,000, which means that the higher tax band starts at £50,000. The examples are based on rental interest of £15,000 and mortgage payments of £9,000, giving a net income figure of £6,000, and a top rate of tax of 40 per cent.
In this case, if the landlord were paying tax on his salary, he will have already paid £2,600 in PAYE, leaving him £1,200 to pay on his rental income, which is 20 per cent of £6,000. So, for lower income landlords, the changes will not involve higher taxes.
In this situation, the tax bill has increased by £1,800 due to interest rate relief being restricted to 20 per cent. Assuming the landlord's salary is subject to PAYE, he will already have paid tax of £17,600, and so the tax on net rental income of £6,000 has effectively risen from £2,400 (£20,000-£17,600) to £4,200 (£21,800-£17,600) - an effective tax rate of 70 per cent on the net profit.
Case 3
This landlord might think he is not affected by the changes because the salary and rental profit come to less than £50,000. However, this example shows that he will still be affected. This is because under the new rules the gross income will exceed £50,000.
Existing landlords have two years to make a decision. They could either pay the additional tax or sell up. In some cases, property might be transferred to a spouse who may enjoy a lower rate of tax. Another alternative is to operate through a limited company, as there are no proposals to restrict the deduction of financing costs within companies. However, this would involve transferring the property into a limited company, which would involve paying stamp duty land tax and, potentially, capital gains tax on the sale. Organising a new mortgage as a corporate structure would provide further headaches. However, the proposal is headed, "Restricting finance cost relief for individual landlords", a point that Mortgages for Business indicates that the tax authorities are aware that corporate buy-to-let investment is not affected.
The bottom line suggests that many landlords will pay more tax, tenants will pay higher rents, and the supply of rental homes might fall as some landlords pack it in altogether.
