Buy to Let Tax Changes
As the end of the 2015/16 tax year approaches landlords are reflecting on the changes announced in the 2015 budget, and what this could mean for their profits and tax bills in the future.
The changes were aimed at higher-rate taxpayers, particularly those receiving income from heavily mortgaged property portfolios. However some basic-rate taxpayers will also be affected where the changes push them into the higher rate bracket.
So let’s have a look at the changes, and what can be done to minimise their impact.
What’s changing?
Currently landlords can offset all mortgage interest against income received from rental properties, with tax relief provided at their prevailing rate of income tax. From 2017 to 2020 changes will be phased in so that landlords will owe tax on the entire rental income from properties, with a 20% tax credit provided on mortgage interest. The phasing of the initiative will see landlords lose a quarter of their higher-rate relief each year until 2020. Effectively by 2020 higher-rate landlords will be receiving just 20% tax relief on mortgage interest. For example a higher-rate individual earning £20,000 from rental income with £12,000 mortgage interest would currently pay £3,200 tax (at 40%); under the new rules by 2020 their tax bill will increase to £5,600 – a rise of 75%.
What can be done?
We expect to see a rise in landlords buying properties in limited companies. Corporation tax rates are currently 20%, and due to be reduced to 19% and 18% in 2017 and 2018 respectively. Aside from low rates of corporation tax, there is the additional advantage that all costs including 100% of mortgage interest can be offset against rental income. Profits can be extracted from the company as dividends; from April 2016 each shareholder receives the first £5,000 of dividends tax free, with subsequent dividends taxed at the individuals prevailing income tax rate (7.5% for basic-rate taxpayers, 32.5% for higher-rate). There can be complications with holding properties in limited companies, such as extracting equity from the company when a property is sold, so it’s advisable to seek further advice before proceeding. Consideration could be given to re-mortgaging properties prior to the changes coming into effect, so that reduced interest payments increase rental profits and offset against tax increases. With some experts forecasting interest rates to rise this year remortgaging sooner rather than later could secure lower interest on a fixed-rate loan. We recommend seeking independent advice from a mortgage advisor. Make sure that income is distributed around your household in the most tax efficient manner. For example you might be a higher-rate taxpayer with rental properties, whilst your spouse could be basic-rate or not fully utilising their personal allowance. Transfers between husband and wife can be done without attracting capital gains tax, so shifting rental income to them could be tax efficient.
Other changes
Landlords with furnished properties have been able to claim an allowance of 10% income to cover wear and tear. From April 2016 the wear and tear allowance is being scrapped; landlords will only be able to claim for wear and tear costs actually incurred. From April 2016 buyers of buy-to-let and second homes will pay an additional 3% on each stamp duty band.
