Expert Tax Advice for Landlords


This week I’m returning to the subject of taxation changes for Landlords. Whilst I know that we covered some of this a few weeks back, it’s always important to ask an expert – so this week I’m going to pass on some great advice drawn up by our friends at Duncan Toplis accountants. As specialists in this area, they can offer you the depth of advice that you need to make sure that you are prepared for the changes ahead.

SUMMARY OF BUY TO LET TAX CHANGES

August 2016

Recent years have seen the introduction of a number of changes to the way that let residential property is taxed. These punitive changes will have a significant impact for landlords moving forward. A summary of the changes, some of which are already in operation, are detailed below.

Furnished Lettings Wear and Tear Allowance

Previously, a wear and tear allowance was given at 10% of the net rents received in respect of fully furnished let properties. This has been abolished with effect from 6 April 2016. In its place all landlords of residential property (whether fully furnished or not but excluding furnished holiday lettings) will only be able to claim the actual cost of replacing furnishings, appliances and white goods.

Additional Stamp Duty Land Tax (SDLT) and Land and Buildings Transfer Tax (LBTT) from 2016

Higher rates of SDLT (LBTT in Scotland) are charged on purchases of additional residential properties (above £40,000), such as buy to let properties and second homes, this was introduced on 1 April 2016. The higher rates will be 3 percentage points above the current SDLT/LBTT rates. These rules impact individuals, trustees and corporate purchases of residential property.

To better demonstrate how the changes in legislation will affect your own circumstances, we have set out an example on page 2.

Relief for mortgage/loan interest for Buy to Let investors

Currently individual landlords receive tax relief at their highest rate of income tax on all of the interest they pay to finance their letting business.

From April 2017 the amount of interest that will be eligible for tax relief at the higher and additional rate (40% and 45%) will be restricted to the following:

75% of the interest paid in 2017/18

50% of the interest paid in 2018/19

25% of the interest paid in 2019/20

The balance of the interest will be eligible for 20% tax relief in each case. From 6 April 2020, only basic rate tax relief will be available for interest paid by higher or additional rate tax payers. A critical point is that these rules apply only to private landlords and do not apply to limited companies. Furnished holiday lettings are unaffected.


Restriction of interest deductibility

Impact of new rules

Adam has built up a fairly substantial rental property portfolio. He has other income of £45,000 from his main employment.

Assuming income tax rates and personal allowances don’t change between now and 2020/21, Adam’s tax positions are compared as follows:

Current rules

2016/17

Future rules

2020/21

Gross Rents

125,000

125,000

Expenses (excluding interest)

(25,000)

(25,000)

100,000

100,000

Mortgage interest

(50,000)

Net rental profits

50,000

100,000

Total tax for Adam (at 40%)

20,000

44,400*

Less: Interest relief (20% x 50,000)

(10,000)

Total tax payable

20,000

34,400

Total tax increase for Adam as a result of the new rules

14,400

*Adam also loses his personal allowance since his total income exceeds £122,000.

Even though nothing has changed in Adam’s personal circumstances, he will, as a result of the changes in legislation, end up paying an additional £14,400 in income tax per annum.

Impact of Incorporation

As discussed above, the new rules restricting interest deductibility do not apply to limited companies, and therefore many commentators are subscribing to the idea that an individual should transfer his/her properties into a limited company.

Using the same example as above, the overall position if Adam were to incorporate his business is detailed in the following pages. As the changes to the interest deductibility rules do not impact limited companies, the net rental profits will be £50,000.

We have considered two of the many possible options for Adam. One where he withdraws all of the net income after corporation tax as a dividend, and another in which he decides to leave the money in the company in order to more quickly repay any borrowing on the properties.

Proceeds withdrawn

as dividend

Proceeds retained

Company Position

£

£

Net rental profits (as above)

50,000

50,000

Corporation Tax payable

(10,000)

(10,000)

Retained income

40,000

40,000

Adam’s Position

Withdrawn as dividends

40,000

Nil

Total income tax payable for Adam

(11,375)

     -

Net retained proceeds

28,625

     -

Total tax payable

21,375

10,000

Tax saved by incorporating

12,625

24,000

As demonstrated by the example above, significant annual tax savings can be made by incorporating a rented portfolio. However, there are a number of potential pitfalls that must be considered on incorporation:

Capital Gains Tax (CGT)

The transfer of residential let properties into a limited company will give rise to a charge to CGT on any increase in value since originally purchased unless incorporation relief is available.

Incorporation relief is available where a sole trader or partnership transfers their business into a limited company in return for shares in that company. In order to qualify for the relief the property letting activity must be sufficient to amount to a “business”.

The scale of activities required to represent a business is a complex area however there is useful guidance in the tax case of Ramsey v HMRC (2013).

If incorporation relief is available the properties receive a tax free uplift in base cost for CGT within the company, making the relief potentially very valuable.

Stamp Duty Land Tax (SDLT)

When moving properties into a limited company the company will have to pay SDLT based on the market value of those properties. In addition the company will be liable for the 3% surcharge applying to the purchase of residential let properties. Therefore SDLT on transfer of the properties could be hugely expensive and must be considered in detail.

There are potential SDLT reliefs, and consideration needs to be given on a case by case basis as to whether these are of benefit. Where a number of properties are transferred there is the potential to claim multiple dwellings relief, or the company can opt to pay non-residential rates if buying six or more dwellings.

There may also be the opportunity in exceptional circumstances and where the properties are held in partnership, to claim incorporation relief under FA 2003 section 15 paragraph 18. However, business activity levels need to be high to justify this and the business must be sufficiently organised to prove that there is a genuine partnership. For instance a formal partnership agreement and preparation of partnership Tax Returns would normally be required. The relief available for partnership incorporations is up to 100% and is therefore a very valuable relief, however this only applies to genuine partnership incorporations and HMRC are likely to challenge any contrived or artificial arrangements.

Refinancing of Loans

A significant potential issue in an incorporation is that the lenders will normally require that the borrower terminates personal mortgages and re-finances in the name of the company. This can cause complications for the borrower and additional costs, so it is essential to check with mortgage providers before an incorporation is contemplated.

Additional Compliance Costs

The company will need to prepare and file annual accounts and returns to Companies House and HMRC. There may also be a requirement to file returns under the Annual Tax on Enveloped Dwellings (“ATED”) rules, although no ATED levy should apply.

Costs for annual accounts, tax returns, ATED and other required filings are likely to cost at least £2,000 - £3,000 per annum so must be considered and budgeted for.

Summary

The impact of the new rules for landlords will have a huge impact over the coming years with many landlords struggling to generate a net income after tax.

As the changes to loan interest relief will apply only to individuals and not to limited companies, there will be a rush to consider incorporation of property letting businesses. However, there are a number of issues that need consideration and incorporation should not be regarded as a one size fits all solution.

If you wish to discuss any element of the changes and how we can help you minimise the impact, please contact our Tax Director, Antony Voakes, on 01522 507000 or email antony.voakes@duntop.co.uk

Disclaimer

This publication is intended for general guidance and is not a substitute for professional advice which takes account of individual specific circumstances. Whilst the information it contains is believed to be correct, no responsibility can be accepted by Duncan & Toplis for any action taken or not taken on the basis of the information contained herein.

I hope that has helped clarify some of these complex issues for you. Remember that your individual circumstances will have a significant effect on your tax liabilities – so do seek out professional advice now, before the changes come in and it is too late!

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