April 2017 sees the introduction of rule changes that will significantly increase the tax cost for many landlords.
If you are a landlord of residential properties, with just over six months until the changes are implemented, now is the time to review your tax position and decide if your rental properties will still be profitable.
The changes will see the tax relief that landlords of residential properties receive for mortgage interest and other finance costs restricted to the basic rate of Income Tax, with a phased introduction beginning in April 2017.
HMRC warn that the changes will:
- affect you if you have residential properties to let as an individual, or in a partnership or trust
- change how you receive tax relief for interest and other finance costs
- be gradually introduced over four years from April 2017.
In future, finance costs won’t be taken into account (as a deduction) to calculate taxable profits from rental properties. Instead, the first step will be to calculate the Income Tax on rental profits and any other income. Then any Income Tax liability will be reduced by a basic rate ‘tax reduction’. For most landlords, this will be a 20% tax credit on the value of the finance costs. It should also be noted that finance costs will no longer be able to create losses, though a form of carry forward relief will be available.
All residential landlords with mortgage interest or other finance costs will be affected, but some will see greater tax increases than others e.g. where the change results in their taxable income exceeding certain income limits/thresholds. The following are examples of some outcomes:
- Higher Rate Income Tax at 40% where total income then exceeds approx. £43,000.
- Liability to the Child Benefit Charge (which typically costs the average family approx. £1,800) where ‘income’ exceeds £50,000.
- Loss of Personal Tax Allowance where income exceeds £100,000, which creates a band of income on which the effective rate of tax is up to 60%!
- Liability to the Additional Higher Rate of Income Tax where total income exceeds £150,000.
The finance costs that will be restricted include interest on:
- Loans (including loans to buy furnishings)
- Fees and incidental costs for getting or repaying mortgages and loans
The restriction will be phased in gradually and will be fully in place from 6 April 2020. During that time, the calculations will be quite complicated as you will still be able to deduct some of your finance costs when calculating taxable property profits, whilst the remaining amount will be used to work out the basic rate deduction. Special attention to (entries on) tax returns will be required as HMRC will be looking for opportunities to open enquiries. Where mistakes are found they will raise extra tax bills together with interest and penalty charges.
Early tax planning discussions are therefore extremely worthwhile; ideas to explore but will need careful consideration are:
- Married couples/civil partners – if properties are not in joint names already, consider this as a first step to gaining access to both individual’s tax allowances and rate band etc and the possibility of diluting the impact of the new rules by splitting the rental income. Do take care, though and assess the impact of potential Stamp Duty Land Tax (SDLT) charges if mortgage liabilities are transferred.
- Depending upon family relationships and ongoing requirement for income/assets for later life – shares in the property could be gifted to adult children who may be liable to lower rates of taxation. Possible Capital Gains Tax (CGT) and SDLT implications of gifting would need to be considered.
- Incorporation (Limited Company) – for individuals with just a couple of properties use of a limited company would not generally be suitable. However, in other cases, transferring ownership to or acquiring any additional properties via a company would allow profits to be sheltered from higher rates of Income Tax to the extent that the individuals don’t need to withdraw funds for living expenses & other projects.
With Corporation Tax set to fall to 17% (by 2020), carrying out rental activities through a company will look even more attractive as it will be possible to retain an even greater proportion of profits to reinvest. Please note, though (in addition to the taxation of rental income) any increase in value of the properties would ultimately be liable to Corporation Tax and then if sold those same funds would incur further taxation when withdrawn by the directors/shareholders.
Also bear in mind the additional admin of running a company and any initial CGT and SDLT liabilities when ownership of the properties passes to the company. In some circumstances there could be possible ways to reduce this but they would need expert advice.
- The rule changes currently only apply to residential properties so you may want to consider whether your property may meet the conditions to be treated as Furnished Holiday Lettings, which could also bring other tax benefits.
Alternatively, consider whether a switch to owning and letting commercial property would be viable.
The content of this blog is for information only and must not be considered as financial advice. We always recommend that you seek independent financial advice before making any financial decisions.
Levels, bases of and reliefs from taxation may be subject to change.
The Financial Conduct Authority does not regulate taxation advice. Active recommends you speak to a Tax Adviser/Accountant for this; Active would be happy to introduce you to one of our close partners.