Approaching increased income tax on your buy-to-let properties? Understanding the impacts will help you plan your response, says Olga Carter, Associate at Bulley Davey
Letting residential property has become popular over recent years, with some of our clients reaping the benefits. However, recent changes to tax have dampened its appeal and limited the feasibility of having vast property portfolios. Under new government proposals, individuals that own and let property are facing a number of changes to the way in which their rental income and, more importantly, the deductions they can make from their rents for income tax purposes, is calculated. These changes include: ● An increase in the rent-a-room allowance. ● The abolition of the wear and tear allowance and the introduction of a new replacement furniture relief. ● The gradual restriction of higher rate income tax relief for finance costs.
Restrictions on tax relief
The most significant change is the restriction of tax relief on finance costs that are allowable against residential property income, which will be introduced in stages from April 2017 to April 2020. This will most effect people who have built their property portfolios by borrowing significant amounts. It applies to individuals, partnerships and trusts, but not limited companies, with finance costs including any fees in obtaining the finance, such as arrangement fees, as well as the interest. For 2017/18, 25% of the finance costs will not be deductible from rental income. Instead, a tax credit equivalent to 20% of these costs will be available to reduce the taxpayers’ final tax liability. For 2018/19 this will be on 50% of the finance costs, with 75% the year after and 100% after that. These figures are in relation to all residential property, not commercial property, with the general feeling that student accommodation would probably classify as residential property also. It is not just the fact that the tax payable only gets basic rate tax relief on these finance costs, but also, as the relief will be given as a tax credit, not a deduction from income, it will increase taxable income for such purposes as high income child benefit and the withdrawal of personal allowances after taxable income exceeds £100k.
What to do
On the basis that these new rules do not apply to companies a lot of individuals are thinking about incorporating their residential letting business. The potential problems to this are Capital Gains Tax on the transfer of the properties into the business, and Stamp Duty Land Tax. However, as long as it could be argued that there was a property letting business, which is not normally too difficult, particularly if there are a number of properties, then the gains could be held over by transferring the property letting business into the company in exchange for shares. If the property letting business is part of a partnership then there is an exemption from Stamp Duty Land Tax. To prove this, the business would need to have had a partnership tax return prepared for previous years. Where there is a portfolio of properties being transferred, it is the average price of each house that sets the rate of Stamp Duty, not the total proceeds of the whole portfolio. In addition, it was noted that a lot of banks would not lend anywhere near as much to companies as a percentage of the property value, as they will to individuals, and any finance may be at a higher rate. There would also be additional administration costs. If you are still unsure what these changes mean for you consider our recommended first steps for you to consider.
1. Meet a tax adviser: A trusted tax adviser will help you prepare calculations and assist with the incorporation of the business if appropriate.
2. Predict the future: Prepare for this meeting by putting together as much information as possible as to what you expect your income and costs to be over the next few years.
3. Explore every avenue: Explore two or three options depending on possible interest rate changes, then review the situation again in a few months’ time.
4. Sit tight: Some clients have found the changes are unlikely to affect them to any material extent for at least a couple of years after the changes start to be phased in.
5. Don’t rush: One or two of the lenders are already looking at what changes they may need to make, which might mean the finance costs on incorporation may come down. So don’t rush into any major changes but do start putting together business plans to see how it would affect you.
Bulley Davey 4 Cyrus Way, Cygnet Park, Hampton, Peterborough PE7 8HP. 01733 569494, www.bulleydavey.co.uk