On the 8 July 2015, George Osborne announced a number of changes to the taxation of property businesses. The important is the loss of higher rate tax relief for finance charges, which includes mortgage interest. Also many landlords, who were previously basic rate tax payers, will be pushed into the higher rate tax band.
Consider Mr Patel who has built his property rental business by maximising the use of low interest rate mortgages.
He has built up his rental business profits (after deducting costs excluding mortgage interest) to £120,000 a year. All his mortgages are interest only and the annual interest charges are £100,000. He is content to manage on the modest £20,000 income that this provides as he is in the business for the long term – waiting for long term growth in the capital value of his properties.
Up to the tax year 2016-17 he can deduct the £100,000 from the £120,000 and pay tax on the difference. For 2016-17 this will amount to just £1,800.
After 5 April 2017, new legislation will disallow an increasing percentage of the mortgage interest as a business expense, until by 2020-21 none of the £100,000 will be allowed as a deduction when computing tax payable. At a stroke, and with no change in property income and outgoings, Mr Patel’s taxable profits from his property business will increase from £20,000 to £120,000.
Mr Patel will become a higher rate tax payer and lose much of his personal tax allowance as his income exceeds £100,000.
Relief for his mortgage interest payments will be given by a basic rate tax credit. For 2020-21 this will amount to £20,000 (£100,000 x 20%).
Unfortunately, even with this tax credit taken into account, Mr Patel’s Income Tax liability for 2020-21 will rise to £19,500 (based on current information available). This is a massive increase and it will consume most of his property business cash flow.