Led by Robert Dowling at Carpenter Box, the MHA Construction & Real Estate team have worked together to provide a national outlook on the changes facing Buy to Let landlords over the course of the next 12 months. MHA is a national association of independent accountants which Carpenter Box helped to found in 2010.
This is the second of two articles (see issue 27 of Platinum Business Magazine for the first) to help you better understand the changes that landlords now face and which looks at ways that landlords can reduce their tax burden.
Changes to tax relief on finance costs
Currently, individuals receiving rental income from residential properties can offset finance costs incurred in full against the rental incomes received. This results in reduced property profits that are subject to tax. These rules are broadly aligned with other businesses and self-employed individuals who are able to claim business costs against business incomes.
Tax relief for finance costs on residential properties will start being restricted for landlords; this is a significant shift from the rules that apply to other businesses. Furthermore, the mechanics of how tax relief on finance costs on residential rental properties is obtained is also changing, which may have further financial consequences for the taxpayer.
The restricted tax relief will be phased in from April 2017 and by 2020/21 landlords will only be able to claim basic rate tax relief on the financed costs incurred. Finance costs typically include mortgage interest, but also include interest on loans to buy furnishings and bank arrangement fees and charges.
How the new rules will work:
Deductions of finance costs from property income will be restricted to:
• 75% for 2017 to 2018
• 50% for 2018 to 2019
• 25% for 2019 to 2020
• 0% for 2020 to 2021
Individuals will be able to claim a basic rate tax reduction from their income tax liability on the portion of finance costs not deducted in calculating the profit. In practice this tax reduction will be calculated as 20% of the lower of the:
• Finance costs not deducted from income in the tax year (25% for 2017 to 2018, 50% for 2018 to 2019, 75% for 2019 to 2020 and100% thereafter);
• Profits of the property business in the year;
• Total income (excluding savings income and dividend income) that exceeds the personal allowance and blind person’s allowance in the tax year.
Any excess finance costs may be carried forward to following years if the tax reduction has been limited to 20% of the profits of the property business in the tax year. See example 1 below.
Other financial consequences
The new rules also change the reporting of rental profits within the constitution of what is regarded as an individual’s income.
Before April 2017, profits from rental income, being rents received less interest and other property expenses, are reported as income.
After April 2017, rental income before the deduction of finance costs will be regarded as an individual’s income.
This change will result in an increase to the individual’s income being reported, which may in turn give rise to an increased High Income Child Benefit Tax (HICBT) charge and additional Child Maintenance costs, for instance. It may also push the taxpayer into a higher tax bracket whereby the personal allowance available will be restricted or it may push the taxpayer from the higher rate 40% tax bracket into the additional 45% tax bracket.
As the new rules only affect residential properties, if you have a mixture of residential and non-residential properties in your property portfolio, you may wish to consider moving borrowing away from the residential properties and borrow instead on the nonresidential properties. You will then be able to obtain full tax relief on the finance costs incurred. However, the change in borrowing may result in mortgage early redemption penalties and further bank arrangement fees, which you will need to consider and take into account.
Alternatively, with careful exploration, incorporation may be advantageous with the rental properties being transferred into a corporate shell paying Corporation Tax at 18%. Corporation Tax rates are due to reduce over the coming years, but with the change of Chancellor this may be reviewed.
Careful consideration will need to be given to potentially significant Stamp Duty Land Tax (SDLT) and Capital Gains Tax (CGT) charges, which may arise as a result of the transfers, but also how to efficiently extract the profits from the company.
However, recent case law indicates that it may be possible for incorporation relief to be claimed, allowing the capital gain arising from the transfer to the company to be deferred until the properties are onward sold by the company. This may only be possible where there is a strong argument that the properties are being actively managed and specific tax advice should be obtained before implementing such a strategy.
The SDLT charge arising may also be reduced by claiming multiple dwellings relief where appropriate. This will have the effect of the rate of SDLT to be averaged down to the market value of each dwelling within a property.
Should you wish to talk about business or tax advice around the construction and the real estate sector, you can contact Robert on 01293 277670 or by email at firstname.lastname@example.org.
Example: A landlord paying tax at the additional rate (45%) with rental income of £25,000 and mortgage interest of £20,000
Rental income: £25,000
Mortgage interest: (20,000)
Tax liability @ 45% (£2,250)
Rental profit after tax: £2,750
Rental income: £25,000
Mortgage interest: (20,000)
Tax liability @ 45% (£7,250)*
Rental loss after tax: (£2,250)