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New legislation on mortgage interest tax relief will come into effect in April 2017. The move, first introduced by Chancellor George Osborne in 2015, will mean that the amount of tax relief that landlords of residential properties can claim, in respect of interest payments on buy-to-let mortgages, will be restricted to the basic-rate of income tax. This alteration could have a considerable negative impact on the profit margins of landlords.

A breakdown of how the new buy to let tax relief it works:

– Landlords pay tax on their profits according to their income tax band, ranging from 20% to 45%.
– The former Chancellor, who left his role in 2016, announced that landlords would no longer be able to deduct all their mortgage interest when calculating their profits.
– Between 2017 and 2020, mortgage interest tax relief will be gradually cut back to just 20%. Landlords will in future have to pay tax on the full amount less a 20% credit on the mortgage interest.

What does this mean?

Essentially, higher-rate and additional-rate taxpayers could see their returns severely reduced. The new tax will wipe out returns of a higher-rate tax payer if the mortgage interest is 75% or more of the rental income, and the threshold is 68% for additional rate payers, according to Smith & Williamson, the accountant. However, the tax liability of a basic-rate taxpayer should be unchanged.

Are there any loop-holes?

As limited companies are not affected by the change, many landlords are creating companies and transferring the property from individual ownership to company ownership. This is a tactic to minimise the impact of the new tax regime and retain profit levels. However, as HMRC view the transfer of ownership as a sale, private landlords may face a capital gains tax bill if they follow this route. A further complication is that mortgage options might also be limited because mortgage lenders only offer a restricted choice to companies. Expert tax advice will now be essential for the majority of private landlords.

Rose Jinks of Just Landlords advised against the practice of creating limited companies, saying ”Although swapping to a limited company structure could be beneficial for your business, now is the perfect time to analyse all of your options and weigh up whether moving to a limited company in order to avoid the change will actually be worthwhile. For our customers, it certainly seems that sticking with the traditional structure is the best way to go.”

An alternative solution to this new tax regime is that a landlord could also transfer ownership of the property to a spouse or partner who is in a lower tax band. However, there could again be capital gains tax implications on the transfer of the property. There could also be issues if the revised ownership arrangement pushes the new owning individual into a higher tax bracket.

What are the effects?

The new legislation could lead to landlords trying to raise rents, in an effort to recoup some of their lost profits. Mark Lawrinson, Regional Director, Portico notes, “There are steps landlords can take to try and cut their interest costs. Buy-to-let mortgage interest rates have fallen significantly in recent years, so deals currently on the market may well be substantially better than on products arranged a few years ago.”

Overall, studying the new tax relief changes, seeking good quality independent tax advice and researching the best mortgage deals on the market will ensure that you are not adversely effected by the changes.

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