Tax changes affecting landlords

It’s no secret that Devon and Cornwall are hotbeds for landlords with residential portfolios.

Dig a little deeper and you will find many of those buy-to-let landlords are having to adapt to a raft of recently introduced tax measures.

Mortgage interest relief

Changes to mortgage interest relief are chipping away at the amount of rental income landlords can declare after they have paid their mortgage.

Until 2017/18, buy-to-let landlords had been able to deduct all of their finance costs from their property income and reduce their tax bill as a result.

Since then, however, this tax break has been eroding at a rate of 25% a year, and will eventually be replaced by a basic-rate tax credit from 2020/21.  

For 2019/20, residential landlords will only be able to deduct 25% of their finance costs with the remaining 75% given as a basic-rate tax reduction.

January 2019 provided the first data point to measure its impact, with the average buy-to-let landlord paying £3,039 more in tax for 2017/18.

As a result, an increasing amount of landlords who operate as sole traders are changing business structure.

Incorporating your business enables you to deduct your mortgage expenses from your rental income and continue to reduce your tax bill.

Continuing to operate as a sole trader presents a conundrum: sell up, pay more tax through self-assessment or change business structure.

The changes to mortgage interest relief do not apply to landlords with furnished holiday lettings or second homes.

Lettings relief

To understand lettings relief, you need to understand the concept of capital gains tax.

Capital gains is a tax paid on the profit made on an asset between the point of purchase and the point of sale. In this case, that asset is a property.

You may need to pay capital gains tax if you have let out your home, although how much you owe is determined by how long you lived there.

What you pay is minus private residence relief, which is available for the period of time you lived in the property.

For example, let’s say you owned a home for 10 years and made a gain of £100,000 when you sold it. You lived in the property for 5 years, and let it out for 5 years.

Private residence relief is available for the 5 years you lived there, and you may also get to claim the final 18 months before you sold it.

This gives you 6 years and 6 months of relief, which equates to 65% of the 10 years you owned the property.

This means you won’t pay capital gains on the first £65,000 of your profit, although the remaining £35,000 is chargeable.

Lettings relief can reduce your capital gains liability further, offering you the chance to get whichever is the lowest of:

• what you received in private residence relief (£65,000)
• £40,000
• or the chargeable gain (£35,000).

Going back to the example, lettings relief would cover your chargeable gain meaning you pay no capital gains tax in 2019/20.

The final 18 months would be reduced to 9 if you were to sell in May 2020. Revisiting the example, private residence relief would apply to 5 years and 9 months.

Only 57.5% of the 10 years would be exempt through private residence relief, and your chargeable gain would be £42,500.

While lettings relief of £40,000 is available, you will need to prove you were in a shared-occupancy agreement to qualify for it.

If you are unable to verify that agreement, the whole £42,500 gain would be chargeable.

Contact us

There is far more to both of these tax breaks than meets the eye, and our team of experts are on hand to explain them in more detail.

For more information, email us on info@stapletonsaccountants.co.uk or call us on 01363 773191.