Could this be the end of the Buy-to-Let UK property business?

Could this be the end of the Buy-to-Let UK property business?

What’s changed?

Tax is charged on income received from rental properties. This is calculated as rent less allowable deductions such as:

  • Rental insurance
  • Repairs and maintenance costs
  • Professional fees
  • Mortgage Interest

As announced in the budget, the Chancellor has introduced restrictions on tax relief on mortgage interest with effect from April 2017. Interest relief restriction will be introduced gradually until it reaches the basic rate (20%) which is expected to be in 2020.

 

Who’s affected?

Individuals that receive rental income on residential property in the UK or elsewhere and incur finance costs (such as mortgage interest).  So if you are lucky enough not to have any mortgage interest cost on your property or you own property through a company or your property meets all the criteria to be classed as a furnished holiday letting, this has no effect on you.

What’s the issue?

At present, landlords can deduct relevant finance costs (mainly mortgage interest) as an expense of their property business.  This relief is effectively given at the taxpayer’s highest rate of tax.

The government says this is not fair for lower rate tax payers. To make the tax system fairer, the government will restrict the amount of Income Tax relief landlords can get on residential property finance costs (such as mortgage interest) to the basic rate of tax. This will ensure that landlords with higher incomes no longer receive the most generous tax treatment.

This can be illustrated by way of an example below:

Assume the tax payer is a higher rate payer so has used up all his basic rate band. Aside from his other income, he has property income of £30,000, no deductible property expenses other than £20,000 in mortgage interest.

 

Before the changes: £
  Gross property income 30,000
  Mortgage interest 20,000
Taxable net property income 10,000
Ignoring the other property expenses, this tax payer has already used up his basic rate band so affectively will pay £4,000 in tax on his property income being 40% on £10,000

 

After the changes: (fast track to 2020) £
  Gross property income 30,000
  Mortgage interest*  –
Taxable net property income 30,000
* interest relief only given as a deduction from his tax due on property income before interest and is restricted to 20% of the total mortgage interest paid
Therefore gross property income of £30,000 will suffer a tax of £12,000 (30,000 @ 40%) from which an interest relief deduction of £4,000 (£20,000 @ 20%) will be due making the total tax payable on property income alone of £8,000 (£12,000 – £4,000). Compare this with £4,000 tax that’s was due above.

 

 

Any cost mitigation options?

Several ideas are currently floating around on how to mitigate the loss from these changes. I briefly touch on a few of them below:

  • Remortgage
    • If you can manage to remortgage at a lower than your current interest rate thereby reducing the annual interest costs, this will reduce your exposure for when the new changes kick in. Fixing rates would also help as current interest rates are so low that the only way is up and that will be sooner than later.

 

  • Use of spouse’s personal allowance
    • If the rental income is in your name i.e. it is taxed on you and you have a spouse who is not currently using up all their annual personal allowance, you can exploit that situation by apportioning some of the property income to them. Current personal allowance is £10,600 and is set to rise to £12,500 by 2020. For higher rate tax payers shifting £12,500 of rental income to a spouse who is has no other income could easily save up to £5,000 in taxes!

 

  • Form a company
    • The rate of corporation tax is set to reduce to 18% by 2020, just when the restrictions on mortgage interest kick in. The proposed restriction is for individuals not companies. So investing in property via a company will become more attractive. This has to be carefully considered though with your solicitor and accountant especially if you want to move personal property you already own into a company that you control as that is a disposal between two connected parties therefore deemed to take place at market value for capital gains tax purposes thereby creating a capital gain/loss in your hands. Other considerations might be whether the bank is willing to lend to a company and also the costs of renegotiating your mortgage arrangements.

 

  • Balance sheet re-organisation
    • If you have a portfolio of properties and are highly geared, you might consider selling some to repay some of the loans thereby reducing your total interest payments thus cutting down on the exposure to interest restrictions.

 

What can I take away from this?

Even if at the end of the day, you decide not to do anything about this I think it’s worth a review and just quantifying the impact of the changes on your property tax bill, consider the costs and benefits of taking any action and see where you stand.

The fact of the matter is there is no easy solution to this problem and as always there is no one-size-fits-all type of solution. For example some properties could be loss making income-wise but an investor may be persuaded to hang on to them for their capital growth potential than their income stream. A carefully considered decision will be needed in order to arrive at a given form of planning.

Some commentators have said that whilst government has good intentions of changing the scenario where it’s easier for property investors to purchase property than it is to get on the property ladder, the measures in their current proposed form may be counterproductive in that investors may simply pass on the cost thereby raising the rent disadvantaging the same people this was meant to help.

 

 

September 2015

 

 

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