Thousands of landlords could be forced to make substantial changes to their businesses because of cuts in tax relief on loans, the Bristol office of accountancy, investment management and tax group Smith & Williamson is warning.
The firm’s experts say many of those who own residential property will have to pay more income tax on rental income due to cuts in tax relief on finance costs, including mortgage interest.
Smith & Williamson Bristol private client tax team partner Helen Demuth, pictured, said: “As a result, some landlords may find they are paying more in tax than they are receiving in net rental income. 
“As a rule of thumb, if mortgage interest payments are more than approximately three quarters of the rent after deducting other costs, a landlord paying income tax at 40% will find their tax bill wipes out any profit on the rent.
“Therefore, those who have borrowed heavily against the value of their property are likely to suffer the most, while those who own the property outright, without any loans, will not be affected by the income tax changes.”
An extreme example would be someone with £10,000 net property income after loan interest of £90,000 a year, and who currently pays £2,000 tax at 20%. Under the new rules, they could trip into the 40% tax rate and get an additional tax bill in excess of £22,000, leaving them with a cash deficit. This is essentially because rental income will be assessed for tax before finance costs are taken into account.
She added: “Even someone in a more modest situation, earning at or just above the higher rate threshold, with, say, gross rents of £20,000 and mortgage interest of £15,000 a year could find that their profit is eliminated by the new tax charge. An increase in interest rates could make the situation even more difficult, especially for landlords with larger loans.”
Smith & Williamson is urging landlords to think carefully about the way in which they own rental property, to mitigate the effects of these new tax rules. For some, it will be more appropriate to hold property in a corporate structure, while others, such as investors, may need help in setting up more sustainable arrangements.
The changes are being phased in gradually between April 6, 2017 and April 5, 2021. However, because of the far-reaching implications and illiquid nature of property, landlords are urged to review their situation in plenty of time.
In addition, from next April, owners of buy-to-let properties, whether furnished or unfurnished, will be able to make a specific claim for the actual cost of replacement furniture, furnishings, appliances and kitchenware provided for their tenant’s use in the house.
This can include, for example, beds and linen, through to free-standing fridges and cutlery. The replacement of fittings, such as elements of a fitted kitchen, are to continue to be treated as allowable repairs.
The new allowance replaces the 10% ‘wear-and-tear’ allowance available to landlords of fully furnished properties, on April 5 next year.
