The scrapping of mortgage interest relief and rental yield in the Medway Property Market

This week I gave a presentation at Business Over Breakfast Medway about me and my lettings business. It was a great to have a discussion with the business people of Medway about where to invest in Medway and the varying rental yields attainable in different areas. In places where rental yields are high, there is a tendency to have a slower rate of capital growth, whilst those streets with low yields tend to have a high capital growth. So investing in Medway is about striking a balance between the two and having a property with a decent rental income alongside good prospects for capital growth.

For a first-time landlord investing in the Medway property market calculating your rental yield could appear confusing but it is in fact very simple. Your annual rent minus expenses is divided by the cost of the property (including legals and Stamp Duty).

It is vital that your net rental yield is high enough to cover costs and provide you with a profit. In the past investors would have properties that ‘washed their faces’, meaning that the rent just about covered the outgoing mortgage expenses, in the hope that capital growth would provide them with a profit. As a basic rule I would avoid any investment below a 6% yield and aim for 8% plus.

Current Mortgage Interest Tax Relief

This is so important now due to the replacement of mortgage interest relief with a basic rate allowance. For example assume the below represents a buy-to-let of yours:

£12,000 rental income.
£5,000 mortgage interest costs.
£1,000 maintenance and other costs.

Therefore you have £6,000 profit.

As a basic rate taxpayer (20%) you would pay £1,200 in tax.
As a higher rate taxpayer (40%) you would pay £2,400 in tax.

From April 2020

When the changes are fully implemented with the same above example:

£12,000 rental income.
£5,000 mortgage interest costs.
£1,000 maintenance and other costs.

Now you have a profit of £11,000 (£12,000-£1,000) as the mortgage interest costs are not included in profit calculation. However, you will still be entitled to a basic rate allowance against the mortgage interest costs. This is 20% of mortgage interest costs, regardless of whether they are a higher rate or basic rate taxpayer.

So in this example there would be a £1,000 basic rate deduction (£5,000 x 20%).

basic rate taxpayer (20%) would have a £2,200 tax bill minus the basic rate deduction of £1,000 this totals £1,200.
higher rate taxpayer (40%) would have a £4,400 tax bill minus the basic rate deduction of £1,000 this totals £3,400.

As you may have noticed, the tax bill for the basic rate taxpayer is the same before and after. However, the effect of these changes pushes up the ‘profit’ of the basic rate taxpayer. Instead of making £6,000 profit this is now counted as £11,000 for tax purposes. Therefore a landlord with a couple of buy-to-lets or with an additional income could be pushed up tax brackets and therefore end up paying a lot more tax. If this will affect you, it is worth taking a holistic look at your finances alongside an expert to consider all your options.

When and how will this be coming into effect?

The new measures will be phased in gradually from April 2017 as below.

2017-18 – 75% of finance costs, 25% basic rate tax deduction.
2018-19 – 50% of finance costs, 50% basic rate tax deduction.
2019-20 – 25% of finance costs. 75% basic rate tax deduction.
2020-21 – 100% basic rate tax deduction.

So what should I do?

As the changes stand right now it will make sense to consult with an accountant and independent financial advisors to build a strategy. Transferring your holdings into a limited company may be one solution as mortgage interest will continue to apply here. However this may expose you to capital gains tax so it is important to take this decision depending on your own personal circumstances.

For your current properties, you should be making sure you are getting the best return on investment with your Medway property. What does this mean? Well, you should be getting the highest rent possible and minimising your void periods through proper systems and processes. If you want any advice or to talk about these matters, feel free to get in touch. My number is 07944 726676, or you can email me at hasan@bullfinchproperties.co.uk.

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