Buy-to-let investors - tax changes ahead
Buy-to-let investment in property has been a popular choice now for many years among both UK residents and non UK residents. Rising capital values have produced capital appreciation whilst the rental profits have also been reduced for UK tax purposes by deducting mortgage interest in arriving at the taxable profit. For a higher or top rate taxpayer, tax relief on this deduction has been at their marginal rate, i.e. 40% or 45%. Consequently, a 45% taxpayer with a buy-to-let portfolio paying for example £40,000 mortgage interest a year, would receive tax relief at 45% on £40,000, reducing his tax bill by £18,000. That relief will now be significantly reduced, as tax relief will only be allowed at the basic rate of tax at 20% by 2020 and introduced gradually from 6 April 2017. In addition, the 10% wear and tear allowance will be abolished for furnished properties and landlords will be entitled to deduct the actual cost of replacing furnishings instead. As a result of the above, taxable profits will be higher going forward than they would otherwise have been.
At this stage, we need to keep the impact in perspective. Interest rates on bank finance are at a historic low and therefore mortgage interest paid by clients on portfolios is generally small in relative terms. That may of course change as interest rates rise in the future.
Improving the position
Personal ownership is not the only choice and more clients may now want to consider owning future buy-to-let investments through other vehicles, the most obvious alternative being a company.
The rate of tax paid by companies is 20% but is set to reduce further to 19% in 2017 and just 18% by 2020. The company will get a deduction for all of its finance costs in computing the company’s profits. This will clearly produce a lower taxable profit than holding the investments personally. However, further tax will be paid upon extraction of the profits from the company in the form of dividends. There is also a potential double layer of tax as gains on assets sold by the company will trigger a tax charge within the company. A future disposal of company shares will also realise a capital gain for the shareholder on that occasion too. This is often a key reason why corporate ownership is not the preferred choice. However, in practice, not all clients need to extract the profits. Also, depending on individual circumstances, corporate ownership can be for the very long term without any expectation of a disposal of shares for a very long time. These circumstances offer a means of limiting the immediate tax charge until a later date.
At some stage, a shareholder will receive a dividend. There can be more than one shareholder eligible to receive a dividend. Long term planning usually involves the next generation and it is quite common to have a mix of family members amongst a company’s shareholders. Dividend payments to adult children or grandchildren can be a practical and tax effective way of giving them a small income sufficient to absorb their tax free allowances. The new dividend allowance announced today is something to factor in here too.
What about existing properties already held personally?
It is not possible to transfer properties already held into a company without incurring some immediate tax charges, including capital gains tax on gains already accrued in the asset value. This may make restructuring of existing portfolios difficult unless there is sufficient liquidity. It will also depend on individual client circumstances and the long term plan.
Mortgage interest in relation to furnished holiday lets will continue to be deducted in full and not limited to basic rate relief. There are many other considerations when thinking about holiday letting but anyone considering a buy-to-let investment may want to consider this and should take full advice from the start.
The wording refers to landlords and individuals so we await draft legislation to see if this includes trustees.
Rent a room relief
One further change to rental properties, which is welcome, is a rise in the rent a room allowance, which allows individuals to let rooms in their main home to lodgers tax-free up to a prescribed limit. The threshold is being increased from £4,250 to £7,500 per annum.
Is property still a good investment?
Whilst more than halving the tax relief on interest payments may sound detrimental and lead to a change in appetite for buy-to-let investments, with careful ongoing review of circumstances buy-to-let can still work as part of your overall financial plan.
Date: 8th July, 2015
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