By Jo White
Tax Consultant, Spofforths
Question: I have been reading about the mortgage interest relief changes. From what I can gather, as I am a basic rate taxpayer, these changes will not impact me. Is this correct?
Answer: Not quite. It is still possible that these new rules could affect basic rate taxpayers.
Under the changes you will no longer be able to deduct your mortgage interest costs (including arrangement fees) against your rental profits. Instead you will have a tax reducer, calculated based on 20 per cent of the lower of your rental profits (after any losses) and your finance costs. This can mean that some individuals will have higher taxable income taking them into the next tax band.
Take Mr Home for example; he has other taxable income of £25,000 which leaves him with an unused Basic Rate Band of £18,000 (2016-17 rates). With rental profits of £20,000 and interest costs of £10,000, his taxable rental income of £10,000 would be fully taxed at 20 per cent. By 2020-21, when the full changes come into effect, £2,000 of his £20,000 rental profits will be subject to the higher rate of tax. This will mean he will pay an additional £400 in income tax per annum.
Landlords who have losses or very high finance costs could also end up with additional tax to pay.
In order to calculate your taxable rental profits, you have to automatically offset any rental losses arising from previous tax years against your current year rental profits. This could mean your rental profits subject to tax are less than your finance costs. In this instance the new tax reducer will be restricted. Even where you have rental profits, the tax reducer could be restricted where you have little or no other income.
There are advantages too - any unused finance costs can be carried forward so that they can be used to reduce your tax liability in later years. If your position remains unchanged, the level of interest costs accruing could be fairly large. This could potentially mean the rate at which they will be used to reduce your tax charge could be slow.
For more information and specialist tax advice please contact Spofforths.