The welcome reduction in Stamp Duty Land Tax may have encouraged younger investors to rush into becoming buy-to-let landlords. Their parents’ generation has made significant sums of money on the UK property market, so the attractions are obvious. However, the complexity of the UK tax system can mean a higher income tax liability for younger investors, who may be raising a young family while still burdened with student loan finance.
Restrictions to tax relief for mortgage interest on let property were slowly phased in, but they have applied in full from April 2020. This means that the amount spent on mortgage interest is not deducted from property income to reduce taxable profits. Instead it is given as a basic rate 20 per cent tax deduction. This creates the illusion that basic rate taxpayers will not be worse off, but that is not always the case.
Certain payments are based on a person’s total income, such as the High-Income Child Benefit Charge and Student Loan repayments. For these purposes, total income is calculated net of allowable expenses, which previously included mortgage interest. Now, the taxable rental profit will be higher, increasing a person’s overall taxable income. This higher amount is used to calculate Student Loan repayments and test whether you are a ‘high earner’ and need to pay back Child Benefit.
If a parent of two earning £50,000 per year, claiming Child Benefit and who is repaying a Student Loan, also receives £10,000 net per year (before paying the mortgage interest) from a rental property they will find themselves paying an extra £2,728 to HMRC via their tax return. This is the amount of the extra Student Loan repayment plus the clawback of Child Benefit. On top of this, the income tax on the rental profits themselves will also have to be paid. With nearly a third of the profits wiped out by these unforeseen charges, these landlords may be tempted to increase their rents to fund the additional payments to HMRC.
Perhaps some generous parents have started off their Inheritance Tax planning by passing on or purchasing a rental property for their (adult) children. Whilst the mortgage interest relief may not be as relevant, the gift may not provide the level of net income anticipated. It is important that young investors to do the sums beforehand rather than being presented with a nasty shock on their tax returns.