In the past few months, the Chancellor of the Exchequer, George Osborne, has taken steps towards making the buy-to-let market in the UK less attractive by introducing a number of tax changes. These measures have also been introduced to encourage first time buyers to get onto the property ladder sooner rather than later. However, it is still far too early to see how the changes introduced (as well as those scheduled to announced in the March 16th 2016 budget) will really effect the market and stimulate demand amongst the first time buyers. Here we will outline the proposed changes to UK property landlords.
1) Restrictions to Mortgage Interest Relief
At present, property landlords will be able to deduct any mortgage interest payments made in relation to a buy-to-let property in full. The result of this is that if a taxpayer's marginal rate of taxation is 40% or 45% (the top rate of income tax in the UK), these taxpayers will similarly will see their income tax liabilities reduced by 40% (or 45%) of their total interest expense. This is however going to change.
Starting from 6 April 2017, over a 4 year period, the amount of relief obtained on mortgage interest payments will gradually be reduced and eventually capped at a maximum rate of 20% of the total mortgage interest cost (i.e. the same rate of basic income tax, 20%).
Therefore, over the coming years, for higher and additional rate taxpayers, the cost of renting out a buy-to-let property will become 20-25% dearer.
The exact mechanics on how HMRC and the government have proposed to phase in the 20% mortgage interest relief cap is highly complicated. Therefore it is advised that you contact your tax adviser to understand this in greater detail.
2) The additional 3% Stamp Duty Land Tax (SDLT)
Although not confirmed in legislation, during the 2015 Autumn Statement / Budget, the UK government announced it's plans to introduce a higher rate of SDLT on individuals who purchased an additional residential property (for example a buy to let). The effect of this would be to impose an additional 3% SDLT surcharge (on top of the newly revised SDLT rates) for any additional property acquired in the UK in excess of £40,000.
As no official documentation has yet been released in relation to this, it is our understanding (as well as many leading tax practitioners), that upon the acquisition of a new main residence, although you will need to apply the additional SDLT rate on the new property, as long as your old original main residence is disposed of within 18 months, this 3% SDLT surcharge will be refunded back to you by HMRC. The major concern with this is that it could cause significant cash flow difficulties for individuals and families who are acquiring a new main residence.
There will of course be exemptions from the additional 3% SDLT rate, which includes individuals who hold portfolios in excess of 15 properties and also corporate entities. However exact details of these exemptions are yet to be finalised and published.
3) 10% Wear and Tear Allowance will be abolished.
Up until now, for those residential properties that are let out fully furnished, HMRC have allowed taxpayers to claim a statutory 10% wear and tear allowance. This has meant that if a landlord did not require to carry out any repairs or maintenance work in a tax year, they were effectively allowed to claim a 10% deduction against profits (this of course varies if council tax and other utility bills are paid for by the landlord).
From 6 April 2016, this 10% will be scrapped and replaced with a simpler 'replacement basis' for furtniture and fittings. Therefore andlords will only be allowed to deduct the actual costs incurred on replacing furnishings in the tax year.
As with the changes to SDLT above, this was raised during the Autumn Statement / Budget in 2015 and is set to be set in legislation during the upcoming 2016 Budget on March 16th.
So what should you do going forward?
Given the number of changes above, there have been many questions as to whether an individual (or husband and wife combination) should consider incorporating a company to continue operating the property portfolio.
The benefit of operating a corporate structure to own all your properties would mean that full mortgage interest relief could be obtained (as corporates currently suffer a maximum corporation tax rate of 20%), as well as possibly being exempt from the 3% SDLT rate. Additionally, the company may suffer less tax on the rental income earned.
The issue is then that the retained profits are the property of the company and you will then be subject to additional taxes on cash extraction. The rates of tax that you would pay upon extraction would then depend on your total other income as well as the methodology of extraction. Therefore adding the tax payable upon extracting the cash from the company and the tax paid on the profits, this could well amount to being more than if the property(ies) were owned outright by the individual.
Not only this, but in order to transfer the properties into the company, there may be significant costs of administration as well as tax costs. It is then hugely important that given all the potential changes above (and more to come in the future), that consultation with a residential tax expert is taken to map out future tax liabilities and to plan how best to deal with the upcoming changes.
How can Wisteria help?
At Wisteria, we would be more than happy to assist you with your current property portfolio to enable to decide what type of structure your property portfolio should be held in. If you want to discuss the changes and how we can assist going forward, a member of the team would be more than happy to help you, contact us
on 020 8429 9245.