As the tapered erosion of mortgage interest tax relief continues to take effect, it is ever important for individual landlords to take stock of their specific financial positions so that the right preparations can be made.
With criticisms by The Institute for Fiscal Studies, The Institute of Chartered Accountants, representative landlord bodies and a broad spectrum MPs all falling on deaf ears, the chance of any kind of Section 24 reversal is currently looking slim. At best, landlords can hope for some form of retrospective exemption – for example, where properties purchased prior to July 2015 (when the legislation was announced) could potentially claim full mortgage interest relief.
How Will Section 24 of the Finance (No. 2) Act 2015 Affect My Tax Bill?
The magnitude of the impact will entirely depend on what particular tax band a landlord is operating in. In the simplified example below, we assume that Landlord A and Landlady B own very similar buy-to-let properties – valued at £100,000 and achieving a gross yield of 7.2% (£600 per calendar month in rent) at the point of the full effect of the legislation in 2020/21. Both are on the same individual mortgage terms and only differ by virtue of being within different tax thresholds.
In this example, Landlord A (as a lower rate taxpayer) will not be impacted. Landlady B, however, as the higher rate tax payer, will incur a 33.3% decrease in net (post-tax) profits.
Note that the above assumptions also do not factor non-mortgage interest costs such as voids, legitimate running expenses and other holding obligations – which will still remain fully deductible against gross rental income (revenue).
Be Warned: Section 24 Could Push You into A Higher Tax Bracket
Irrespective of your position on the tax banding scale, there are a number of risks to be aware of.
As income tax will effectively be calculated on property-related earnings before mortgage interest payments (revenue effectively being classed as profit), property owners that are currently in the lower tax band may find themselves inadvertently pushed into a higher tax threshold. This would be especially true for those who have taken out a high level of secured debt, are employed / self-employed and/or have other income streams.
Furthermore, should interest rates increase and you struggle to remortgage at competitive pay rates at the end of the term (and therefore be forced to remain on standard variable or revert rates), the higher monthly non-deductible mortgage payments could compromise cash flows. Although remortgaging on a “like-for-like” basis will not be subject to the Prudential Regulation Authorty (PRA) underwriting criteria, aggressively geared landlords/ladies are likely to face challenges in finding a suitable lender.
Potential Solutions to Mitigate the Effects of Section 24
Section 24 should not have a significant impact on your net tax position if your buy-to-let properties are unencumbered or the amount of aggregated mortgage debt is low.
There are some that argue that remaining in the low income tax bracket to avoid the effects of this legislation is the safest position. However, in addition to the risks of being nudged into the higher tax bracket (mentioned above), constantly having to adapt to live within a lower tax band is arguably not the most ambitious of plans.
Moreover, there are a number of potential mitigation strategies including to:
- Deleverage your portfolio (i.e. reduce the overall debt load);
- Transfer some property interests to a spouse or legal partner;
- Divest and effectively clear personally-owned mortgages;
- Increase rents;
- Transfer properties into a Limited company (Special Purpose Vehicle) “wrapper”;
The relative pros and cons of these options are explored in depth in our Property Investor’s eBook, accessible by clicking on the rotating banner below:
Our previous interview with experienced property tax specialist Simon Misiewicz, conducted shortly after the initial phase of the mortgage restrictions (in April 2017), can also be viewed at the following two links: