Next week, landlords will lose the right to claim full tax relief on their mortgage costs, pushing up costs for some significantly.

But in spite of almost two years’ warning, experts suggest that many landlords have failed to plan for rising costs ahead of 6 April.

So what is changing, what does it mean for your income as a landlord and what can you do to prepare?

What’s happening? 

In 2015 the former Chancellor George Osborne announced a series of measures that he claimed would rebalance the housing scales in favour of first-time buyers and away from landlords.

These included the introduction of a 3 per cent surcharge on stamp duty payable on the purchase of buy-to-let properties and second homes, the scrapping of landlords’ wear and tear allowance and the phased reduction of tax relief on buy-to-let mortgage interest.

The first two changes are already in play but the third kicks in next Thursday and will see landlords, who can currently write off their mortgage interest before paying any tax, hit by higher costs.

Over the next three years, this tax relief will taper down and be replaced with a 20 per cent tax credit by 2020, hitting profits for many landlords hard.

What are the changes? 

Currently landlords can deduct both mortgage interest and other allowable costs associated with a let property from their rental income before calculating how much tax is due.

This means the income they have to declare to HMRC is much lower than their rental income, keeping their costs down and keeping many in a lower income tax bracket.

But from 6 April 2017 landlords will see the amount they can write off for tax purposes drop by 25 per cent each tax year until 2020 when they will have to declare all of their rent as income, pay income tax on the total and then claim back for 20 per cent of it as a credit.

This has a double whammy effect: not only will they have to cover more cost out of their rent as the tax relief reduces, they will also see their incomes rise for the purposes of declaring income to the taxman.

It’s estimated that 440,000 basic rate tax-paying landlords will find themselves in the higher rate tax bracket in future as a result.

How will Income Tax be affected?

Mortgage broker London and Country has worked out an example of a basic rate taxpayer with a property let out for £15,000 per year on an interest-only mortgage costing £10,800 per year.

Under the current system, their rental income is judged to be £4,200 because they are able to deduct that mortgage interest before declaring their taxable income.

From 6 April 2017 the same landlord will be judged to have income from the property of £15,000.

If that buy-to-let landlord had a job with a salary of £35,000, under the current system they would remain a basic rate taxpayer with total income of £39,200, but under the new system they would be a higher rate taxpayer judged to have total income of £50,000.

This means they’ll pay 40 per cent income tax on income above the higher rate tax threshold.

What should you do to prepare? 

The overwhelming consensus is that you should review your portfolio as soon as possible to understand the effect these changes will have on your profit.

Some landlords have chosen to talk to a tax adviser to see whether it makes sense to set up a limited company in which to hold their investments for the long-term.

Taking this route will incur capital gains tax, stamp duty and legal, valuation and advice fees however, so be sure to do your sums carefully to make sure it’s worth it.

Another option is to remortgage your existing buy-to-lets onto a lower rate if you qualify for this. Download this calculator, powered by mortgage broker John Charcol, to see how a lower mortgage rate could dramatically protect your profits.

Alistair Hargreaves, of John Charcol, said: ‘As the tax changes are now pretty much upon us landlords need to be talking to their accountants so they can model the likely increase in income tax through to 2020.

‘Then they need to be talking to their broker to see how best to minimise their mortgage costs. This may also include passing the property to a spouse or incorporating. But I cannot reiterate this enough – landlords need to check now to see if they could manage their affairs in a better way, both in regards to their tax, ownership and mortgage products.’

Lenders are of the same view, with Chris Maggs, of mortgage lender Accord, warning that in spite of the fact landlords won’t see the impact until they get their tax bill in 2019, there is no reason to be complacent.

‘Landlords should assess their portfolio as soon as possible,’ he said. ‘A landlord who currently pays tax at 40 per cent with a rental income of £15,000 and £10,000 of mortgage interest will pay £2,500 in tax in the year 2017/2018 compared to £2,000 in the previous year.

‘This means he will see a £500 reduction in his net profit year-on-year, and a £2,000 reduction in net profit overall from the 2017/2018 to 2020/2021 tax years.’

Click here to view the original article ‘Landlords start to lose tax relief from next week’

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