I don’t know if you have got to grips with the tax issues on investment properties yet? If not, below is an overview which you may find helpful.
More importantly Promise is shortly launching a service where your clients can get a free 15 minute telephone consultation with a property tax expert. This should help you avoid the risk of slipping into tax advice if it’s not your specialist area. More to follow on this soon.
As you will know, there are far reaching and fundamental changes to the way rental property income is to be taxed which may come as a nasty shock to many landlords.
Increasingly, brokers are rightly concerned about becoming unwittingly embroiled in giving tax advice or advising on mortgage products where borrowers have not fully explored the tax implications of their actions.
Whilst commercial properties and furnished holiday lettings are not affected by the proposals, last years changes to stamp duty caught many borrowers out when they came to completion and learned of significant stamp duty charges they were not aware of. More complications are unfolding and brokers and their landlord clients need to consider tax planning as part of any purchase or remortgage.
Restriction of tax relief on interest
From 6th April 2017, tax relief on interest paid by landlords of residential properties will be restricted gradually by 1/4 for each tax year.
From 6th April 2020, interest will no longer be an allowable expense in computing the profits of the business. Instead mortgage interest will attract tax relief at 20%.
Joe is a 40% taxpayer. He wishes to purchase a buy to let property. He will be obtaining a £100,000 mortgage. Here is the effect of the change:
Repairs and other tax deductible costs
Interest on mortgage
Net rental profit
Tax at 40%
Less interest relief at 20% on £2,500
Net tax liability on rental income
Tax increase per year
More worryingly a basic rate (20%) taxpayer could also be affected by the changes as the rental income before mortgage interest may take them into the higher rate of tax.
How a basis rate tax payer may be affected
Take the case of John. John has a salary of £11,000. He owns 3 rental properties on which his profit is £32,000 after deducting mortgage interest of £35,000.
See how the changes will affect John.
2016/17 Old liability
2020/21 New Liability
£32,000 @ 20%
£35,000 @ 40%
Mortgage interest relief is £35,000 @ 20%
Effective rate of tax on net income
Where a taxpayer is highly geared the tax liability can be more than the net rental income after paying the interest which could lead to financial difficulties for those individuals.
Removal of the 10% wear and tear allowance for furnished lettings
From 6th April 2016 the 10% wear and tear allowance on fully furnished properties will not be available. It is due to be replaced by a new Replacement Furniture Relief. This means that expenditure on replacing items of furniture and white goods will be allowed but if new items are added then they will not be allowed on the initial purchase.
So what can landlords do?
The effects of these changes can be mitigated in a number of ways which borrowers may wish to consider:
Transfer the ownership of the property to a lower earning spouse.
This is the simplest and easiest way to lower tax liability. But be careful. A transfer between spouses is tax neutral but there may a stamp duty charge if the amount of debt being transferred exceeds £40,000.
They also need to notify HMRC within 60 days if following the transfer the property is held in any ratio other than 50 : 50. Otherwise HMRC will not recognise the transfer until the notification is filed.
Transfer the rental property to a limited company or acquire new properties through a limited company.
Many higher rate taxpayers are now opting for this. Here’s why :-
They get 100% tax relief on the mortgage interest.
Up to £5000 in profit can be taken as a dividend tax free. That could easily be £10,000 if the company is set up with 2 shareholders i.e. husband and wife.
Surplus profits can be used to pay off debt, acquire further properties or fund a pension plan.
Transfer of the properties from individual ownership to a limited company can be done without incurring capital gains tax using section 162 TCGA 1992 relief. There are a number of qualifying conditions but most professional landlords can avoid huge amounts of capital gains tax subject to the qualifying criteria.
The drawbacks are :-
On the sale of a property the company pays corporation tax on any gain after indexation relief. Withdrawing the sale proceeds could be problematic if all the sale proceeds pushes the income into the higher rate band of 40%. Currently the top rate of capital gains tax paid by an individual is 28%.
Transferring existing properties may give rise to a capital gains tax liability as well as a stamp duty charge. Careful planning needs to be given to establish the one off costs of transfer compared to the annual tax increase.
A future budget may make changes that will counter any advantages.
Consider changing the type of property let to either a commercial property let or a furnished holiday letting.
The changes do not apply to commercial property or furnished holiday lettings.
All the above options come with advantages and disadvantages as well as pitfalls, so taking advice is imperative before borrowers take any action. Unless they are suitably qualified, we think brokers should take great care not to slip in to giving informal tax advice and ideally steer clients to a tax adviser so any mortgage advice is given with the input of an independent tax expert.
I hope this information is of interest.
Steve Walker, Managing Director, Promise Solutions
2 out of 3 borrowers get a lower rate than our representative example of a regulated secured loan below:
Mortgages and Remortgages
£80,000 over 240 months at an APRC OF 4.3% and a discounted variable annual interest rate for two years of 2.12% at £408.99 per month followed by 36 payments of £475.59 and 180 payments of £509.44. The total charge for credit is £39,873 which includes a £995 broker / processing fee and £125 application fee. Total repayable £119,873.
Secured / Second Charge Loans
£63,000 over 228 months at an APRC OF 6.1% and an annual interest rate of 5.39% (Fixed for five years – variable thereafter) would be £463.09 per month, total charge for credit is £42,584.52 which includes a £2,690 broker / processing fee. Total repayable £105,584.52.
£4,000 over 36 months at an APR OF 49.9% (fixed) and an annual interest rate of 49.9% would be £216.21, total charge for credit is £3,783.56. Total repayable £7,783.56.
THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME
REPAYING YOUR DEBTS OVER A LONGER PERIOD CAN REDUCE YOUR PAYMENTS BUT COULD INCREASE THE TOTAL INTEREST YOU PAY. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.
If you have been introduced to Promise Money by a third party / affiliate, Promise may pay them a share of any fees or commission it earns. Written terms available on request. Loans are subject to affordability status and available to UK residents aged 18 or over. Promise Money is a trading style of Promise Solutions Ltd. Promise Solutions is a broker offering products which represent the whole of the specialist second mortgage market and is authorised and regulated by the Financial Conduct Authority – Number 681423.
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