Phasing out of buy-to-let mortgage interest tax relief - an update

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The controversial reduction of buy-to-let mortgage interest tax relief started almost two years ago. What are the latest changes and how are they affecting landlords?

July 2015 seems like a long time ago now, but for landlords it remains a significant month as it contained a Summer Budget in which then-Chancellor George Osborne announced a range of tax changes for the buy-to-let sector. Osborne announced that the government planned to reduce landlords' ability to claim buy-to-let mortgage interest tax relief to the basic rate of income tax (20%) over four tax years. After a period of consultation and backlash from the property industry - which culminated in a failed High Court challenge involving Cherie Blair - the reduction began on April 6 2017.

The changes – also known as Section 24 - are affecting many landlords, with higher-rate tax payers seeing their ability to deduct mortgage interest from their tax bill effectively being halved over the course of the reduction. During the first year of the new system, 2017-18, the allowable deduction from property income was reduced to 75%. The following tax year (2018-19), it was reduced by a further quarter to 50%. Now, as we enter the 2019-20 tax year on April 6, the allowable reduction will be reduced to 25%. Next April, as we enter the final tax year of the gradual reduction (2020-21), the rate will be reduced by a further 25% so that it reaches the current basic rate of income tax (20%).

How are landlords coping with the tax changes?

The gradual reduction of buy-to-let mortgage interest tax relief has come at a challenging time for landlords during which they have been hit with various measures which impact their finances and increase their regulatory burden. Among others, these include the stamp duty surcharge, which has increased the cost of acquiring investment properties, the Right to Rent scheme, which has increased landlords' compliance and administration duties, and the tenant fees ban, which could see letting agent management fees rise in the coming years.

One way in which landlords have been limiting the effects of Section 24 is by incorporating their property portfolios. Incorporation sees landlords convert their portfolios into limited companies, meaning they are only liable to pay corporation tax and are subsequently not affected by the changes to the buy-to-let mortgage interest tax relief system. Currently corporation tax is set at 19%, but it is due to fall to 17% for the tax year 2020/21. However, the rate is liable to change on a regular basis, particularly with a change in government. 

Another difference in paying corporation tax instead of income tax is that the returns are due just once a year - based on calculated profits - rather than twice a year, based on estimated profits. For landlords looking to incorporate, they are required to prove that they are letting homes as a business and that their activities meet the ‘business threshold’. It's also important to note that incorporation may incur some significant capital gains and stamp duty costs for landlords.

However, following the announcement of the Section 24 changes, many landlords have chosen to incorporate and the latest research shows this is a trend which is still growing. A study carried out by Precise Mortgages found that some 44% of landlords with more than four properties who plan to make a purchase this year will use limited company status. The figure rises to 64% for landlords with four or more properties, and falls to 17% for those with one to three properties.

"The buy-to-let market is changing and the switch to greater use of limited company status is one aspect of the development underlining the increasing maturity of the sector," says Alan Cleary, managing director of Precise Mortgages.

"There are good reasons why limited company buy-to-let is dominating the purchase market and we expect that will continue to be the case this year and next."

In 2017, before the reduction began, it was reported by Countrywide that a record high 20% of private rental homes were owned by limited companies. Meanwhile, since then, the number of buy-to-let lenders and products catering to incorporation has increased significantly, according to Mortgages for Business.

"It’s been encouraging to see so many new entrants to the specialist end of the buy-to-let market, putting product availability at an all-time high," commented Steve Olejnik, managing director at Mortgages for Business.

"This just goes to show there is still a lucrative, buoyant market out there following on from the recent regulatory changes."

As we move into the 2019/20 tax year and the third year of the buy-to-let mortgage interest tax relief reduction, many landlords will continue to consider the incorporation option. If you do so, it's advisable you seek out the required tax advice before making any big decisions.  

Read more in issue 44 of Li Magazine