We have heard of emergency eviction freezes and the availability of mortgage payment holidays, during this crisis. Landlords have already been bombarded with changes in tax legislation, over recent years. In some cases landord’s return on investment may have already reduced dramatically before this crisis.
In the current tax year 2020/21, the rules for property mortgage interest relief are fully phased in. To add to that additional financial pressure, tenants may have struggled to keep up with paying the rent on their homes. Let us have a look at the taxation position for individual landlords:-
Cash basis of accounting for rent
Fortunately, since the 2017/18 tax year most landlords, with gross rents of less than £150,000, have been using the cash basis to report their rental income. This means that landlords are not taxed on the rent, till it is received.
Some landlords will still use the accruals method for reporting their rental profits. That means that they must report rental income due, irrespective of whether they receive it in that tax year, or not. That could cause an extra financial pressure for some bigger landlords.
Claim all of your expenses
As an accountant, I always tell my clients if you spend it let me know and I shall tell you if you can claim for it. If you do not tell me, I do not know. It is very important that landlords claim for every allowable expenditure that they incur. For higher rate tax payers that is a saving of 40p for every £1 spent and the small amounts really can add up.
Mortgage interest relief
Mortgage repayments (including interest) may be one of the biggest expenses most landlords incur. It is worth pointing out here that the part of mortgage repayments that relate to paying off the capital is never tax deductible.
In the current tax year, 2020/21, landlords cannot deduct any of their mortgage interest payments from their rental income when working out their rental profits. That can have a knock on effect on marginal tax rates and on child benefit higher income tax charge.
However, some tax relief is still available for the mortgage interest paid. From 6th April 2020, individual landlords will now receive tax relief for their finance costs in the form of a tax deduction against their rental profit tax liability. The deduction is calculated at a rate of 20% of the interest.
Can excess mortgage interest be offset against other income in the year?
Now that this new tax relief is fully phased in, it is worth acknowledging here that there are some restrictions in how much relief can be claimed.
Just because you have a tax liability overall for the year, does not mean that you can claim the full 20% deduction for your finance costs!
If your rental profits are less than your finance costs (including mortgage interest), the amount of tax relief that can be claimed in respect of the finance costs will be restricted to 20% of the rental profits. The excess will be carried forward to future years.
If rental profits fall within the personal allowance then the amount of tax relief will be restricted to any income that exceeds the personal allowance (excluding saving and dividend income). So, although you may have a tax liability arising from dividend income you will not be able to relieve any of the mortgage interest against your rental profits. The rental profits will use up your personal allowance rather than it being available to set against savings and dividend income.
As such if landlords are not receiving all of their rental income in this tax year, it is possible that their mortgage interest payments may exceed their rental income and they may not get full tax relief in this tax year.
Claearly if landlords have taken a mortgage holiday they will not be paying those mortgage interest payments.
These mortgage interest relief changes do not apply to corporate landlords.
Rental losses
As the mortgage interest is no longer relieved as a deduction in calculating rental profits, we may find that even in these economically challenging times landlords are still making a taxable rental profit (just not an actual profit in monetary terms).
However, some landlords may have tenants that cannot pay for quite a few months this tax year and then they may struggle to get tenants to rent and have to incur repairs to properties to make them ready for rent again. As such they may find that they do incur a rental loss in respect of other expenditure they incur, even if it is a small one.
Rental losses can only be relieved against rental profits in the tax year they are incurred or carried forward to be used in a future tax year. Any brought forward losses used in a future year will reduce the taxable rental profits in that future year. That may therefore impact on the amount of tax relief that can be claimed for mortgage interest, in that future tax year.
A UK letting business and overseas letting business and furnished holiday letting business are all classed as different businesses, so losses cannot be offset from one type against another.
Please note that the way that corporate landlords can use property losses is different.
Sale of rental property
Just a reminder here for any landlords thinking of selling – speak to your accountant at the same time that you are thinking! They cannot advise you properly, after you have sold.
Also we have new reporting deadlines in place from 6th April 2020. When you sell, or otherwise dispose of, a UK residential property (regardless of whether you have lived in it or not) you now need to advise HMRC of any chargeable gain via a Residential Property Return. That return must be submitted within 30 days of completion. Any tax due on the disposal also needs to be paid within 30 days of completion. This applies even if you submit a Self-assessment tax return each year. In most cases where you have always lived in your house there will be no chargeable gain, but if you have large gardens or have used part of the property for business you may want to check.
As with any reporting requirements, penalties and interest will be charged for late filing and/or payment.
It is important to highlight here that people sometimes dispose of a property without actually selling it. If you gift a property to a connected person, so a family member maybe, that is a disposal and deemed to take place at market value even though no money changes hands.
It is worth speaking to your accountant whenever you are thinking of doing anything, with land or property, so that they can fully advise you as tax can be complex.
Review
Some landlords may not be adversely affected by the way that mortgage interest payments are relieved for tax purposes but others will. Other landlords have already reviewed whether they can transfer some properties to spouses/civil partners or change the way the income is split between them. A few landlords may have also explored the opportunity of incorporating property rental businesses, if they are large enough. Some may have considered buying new rentals in a company and leaving the existing rental properties as they are.
The important thing though is to review your specific situation, run through calculations, consider all possibilities and evaluate what is the best strategy for you, taking account of your short term and long term intentions. What works for one person will not always work for another. The above is just intended to be food for thought and you should always seek professional advice where property is concerned.