Here are some rule changes which may have a big impact on the housing market.
In April 2017, we’ll see the introduction of rule changes that will significantly increase the tax bills of many landlords. In certain cases, some property business models become uncommercial too. With only a short time until the changes come into effect, it’s vital to review your tax position and check whether your letting activities will remain profitable.
What’s set to happen?
Landlords of residential properties will see their tax relief on mortgage interest and other finance costs restricted to the basic rate of income tax, with a phased introduction between April 2017 and 2021.
In future, finance costs won’t be taken into account (as a deduction) to work out taxable profits from rental properties. Instead, the first step will be to calculate your income tax on rental profits and any other income. Any income tax liability will then 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, although 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. An example would be when the change results in your taxable income exceeding certain income limits/thresholds.
Here are some of the issues which may apply:
- Higher Rate Income Tax at 40% where your total income 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 when your total income exceeds £150,000
Restrictions on finance costs
The finance costs that will be restricted include interest on:
- loans (including those to buy furnishings)
Other costs, such as fees and incidental costs for obtaining or repaying mortgages and loans, will also be restricted.
The restriction will be phased in gradually and will be fully in place from 6 April 2020. During that time, the calculations will be somewhat complicated, as you will still be able to deduct some of your finance costs when working out taxable property profits. The remaining amount will be used to work out the basic rate deduction.
You will need to pay careful attention to entries on tax returns, because 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.
It’s therefore worth having early discussions on tax planning with your accountant and exploring some of the following issues:
- Married couples/civil partners
If properties are not in joint names already, consider this as a first step to gaining access to both individual tax allowances and rate band, allowing the possibility of diluting the impact of the new rules by splitting your rental income. You will need to take care, however, and make an assessment on the impact of potential Stamp Duty Land Tax (SDLT) charges if mortgage liabilities are transferred.
- Shares in property
Depending on family relationships – and your 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. You will need to consider possible Capital Gains Tax (CGT) and SDLT implications of the gift.
If you only have a couple of properties, it’s probably not advisable to set up a limited company. In other cases, however, transferring ownership to – or acquiring any additional properties via – a company would allow profits to be sheltered from higher rates of income tax.
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. Beyond the taxation of rental income though, you need to think about any increase in value of the properties that would ultimately be liable to Corporation Tax. What’s more, if you then sold, those same funds would incur further taxation when withdrawn by the directors/shareholders.
It is also worth bearing in mind the additional administration of running a company and any initial CGT and SDLT liabilities when ownership of the properties passes to the company. In some circumstances, there may be some possible ways to reduce this, but you would need expert advice.
The rule changes currently only apply to residential properties, so you should consider whether your property may meet the conditions to be treated as ‘furnished holiday lettings’, which could also bring other tax benefits.Alternatively, it might be worth considering the viability of switching to the ownership and letting of commercial property.