Buy-to-let tax changes bite with rising interest rates

Pam Henley

Private Client Adviser

Changes to tax rules made some years ago could soon cause financial pain as interest rates rise.

It’s now seven years since former Chancellor George Osborne announced sweeping changes to the tax rules for buy-to-let (BTL) residential properties, whereby landlords could no longer claim mortgage interest as a tax-deductible expense. The Chancellor decided to replace this treatment with one in which:
• interest could not be deducted from rent, thereby increasing the tax charged on rental income and, as a consequence, the property owner’s total taxable income.
• a tax credit of 20% of interest paid would be given instead.

The reform was dramatic enough to phase it in over four years from April 2017, meaning that it did not take full effect until the 2020/21 tax year. By then, the Bank of England had reduced its base interest rate to 0.1% in response to the Covid-19 pandemic. Consequently, the reduction of tax relief on interest was far less of an issue for BTL investors in 2020 than looked likely in 2015.

However just over two years later, the picture is altering rapidly, as the Bank of England continues to ratchet up interest rates to deal with soaring inflation. Recent research by estate agent Hamptons International calculated that for some higher rate tax payers, an increase in BTL variable mortgage rates of 2% could reduce their net income to zero. For example:

*Based on 75% mortgage on a property valued at £202,000 with a gross rental yield of 5.94% and expenses at the average rate reported to HMRC in 2020/21. Tax treatment varies according to individual circumstances and is subject to change.

Whilst some attractive deals are still on offer, they are unlikely to remain in place for long in view of growing expectations of rate rises and inflation. Chris Sykes, technical director at mortgage broker Private Finance, said: “Whether or not you can take advantage now depends on whether you can secure a property, or your remortgage is due. It’s not always simple but if you can move forward now, or you’re on a standard variable rate, I would recommend you do.”

Actions to consider
The dramatic change to interest and tax relief highlights the risks inherent in borrowing to invest. If you are a BTL investor and currently have a variable mortgage rate, you should consider whether or not it is appropriate at this time to fix your rate in light of the expectation of further interest rate changes.

The recent changes in interest rates and inflation demonstrate the importance of regularly reviewing your financial position and seeking advice, as this can make a big difference to your overall financial position. If you are concerned about your investments or wider financial plans, please don’t hesitate to contact your Origen adviser, or our Client Services Team.

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