STOP THE PRESS – Landlords!! A must read!

Do you own residential buy to let properties? Do you have a mortgage on the properties? Are you a higher rate tax payer?

If you answered yes to all three questions, then you should read on.

Relief for interest

It was announced in the Summer Budget that landlords with residential property portfolios will be restricted from claiming full tax relief on any mortgage or loan interest paid.

Ultimately from April 2020, any tax relief for interest paid on a mortgage or similar loan will be restricted to the basic rate of income tax. However, to allow landlords to adjust to the new measures, reduction will be phased in over four years.

From April 2017, interest will be relieved at the rate of 75% at higher rate (40%) and 25% at basic rate (20%).

From April 2018, interest will be relieved at the rate of 50% at higher rate (40%) and 50% at basic rate (20%).

From April 2019, interest will be relieved at the rate of 25% at higher rate (40%) and 75% at basic rate (20%).

From April 2020, interest will be relieved at the rate of 0% at higher rate (40%) and 100% at basic rate (20%).

Example

This is best illustrated as an example – Take Roger who is a higher rate taxpayer. Roger has one buy to let property which generates £5,000 rental income per year. His mortgage is a long term fixed rate and the interest charge is £4,000 per annum. He has no other rental expenses.

Roger’s ‘profit’ each year is therefore £1,000 and before the new measures were introduced, he would pay 40% tax on this i.e. £400. Roger’s ‘profit’ will be increased due to the new measures restricting the relief for the interest, which in turn means his tax liability will increase.

 

Inc + Exp

 

2016/17

2017/18

2018/19

2019/20

2020/21

Rent

5,000

 

 

 

 

 

 

Tax @ 40%

 

 

2,000

2,000

2,000

2,000

2,000

 

 

 

 

 

 

 

 

Interest

(4,000)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Relief @40%

 

 

(1,600)

(1,200)

(800)

(400)

 

Relief @20%

 

 

0

(200)

(400)

(600)

(800)

 

 

 

 

 

 

 

 

Profit

1,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Tax Payable

 

 

400

600

800

1,000

1,200

 

The tax charge for 2017/18 can be reconciled as (£5,000 x 40%) less (£4,000 x 75% x 40%) less (£4,000 x 25% x 20%).

Hopefully it is clear to see that from 2020/21, Roger will have a tax bill of £1,200 on a taxable ‘profit’ of £1,000.

Ultimately, the profit may be covering the capital element of any mortgage repayments leaving Roger to find £400 each year to pay his tax bill. However, come January 2022, Roger will have to find £1,200 to pay the 2020/21 tax bill as well as a further £600 towards his tax bill for 2021/22.

Clearly this is going to affect a large number of landlords who will have unforeseen tax liabilities and also encounter complications in calculating the appropriate amount of interest relief, particularly where mortgage statements do not tie in with the tax year.

What can be done?

Some options available are to consider:

1.       Incorporating the rental portfolio into a company as companies are not affected by the new changes. However, you would need to consider stamp duty and capital gains tax on any transfer in addition to any requirements of the mortgage lender.

2.       If the properties are run as a business, rather than a passive investment, then the interest relief may be available in full. However, HM Revenue & Customs usually take a lot of convincing that a property portfolio is a business and there is the added cost of self employed national insurance to consider.

3.       Increase rents – possibly an unpopular move with any tenants, which will also increase the tax bill but for every £100 increase, the landlord would have £60 after tax which may help set off some of the additional tax due as a result of the decrease in allowable interest costs.

4.       Sell the property – possibly a drastic move and capital gains tax needs to be considered as well as the investment of any proceeds.

5.       Ensure that all of the allowable expenses are claimed to reduce tax.

6.       If your spouse pays tax at a lower rate, then you should consider the beneficial ownership of the property. It is legally possible to write a trust deed to reallocate income 1% to you and 99% to your spouse.

7.       Remortgage the property – if you bought the property for £150,000 and the mortgage is £50,000, then you could remortgage the property and claim more interest relief (as long as you do not borrow more than the original cost price) which could reduce your tax bill. Whilst this will mean that you pay more interest, if you were going to remortgage your own home to build an extension, then this at least gives you some tax relief for extending your own home! Clearly care needs to be taken and financial advice sought particularly as interest rates are only going to rise in the future.

8.       Consider ways to reduce the higher rate tax payable on the profit – pension contributions and gift aid donations being two of the main ways.

 

Wear and tear allowance – soon to be worn out!

Those landlords that provide a fully furnished property for their tenants are able to claim a wear and tear allowance for the costs of replacing furnishings – beds, sofas, TVs, fridges, carpets, curtains etc.

The allowance is 10% of the relevant rental amount. The relevant rental amount is the rental income less any costs usually borne by a tenant – water rates, council tax etc.

However, this allowance is to be abolished from April 2016 and instead of the allowance, the landlord will need to claim the actual costs of replacing furnishings. Therefore the landlord will need to keep more detailed records.

Rent a room

Finally, some good news......

For those landlords that let out a room in their own home, the “Rent a room” relief level of £4,250 will be increased to £7,500 from April 2016.

Of course, the relief needs to be claimed by completing a Self Assessment Tax Return and should you need assistance with this, please do call us.