The new rules look set to have a significant financial impact – not least the Government’s plan to cut mortgage interest tax relief.
For example, if you have a property providing £1,000 rent per month with a monthly mortgage interest payment of £800, you pay tax on the £200 difference between the rental income and mortgage interest.
Under the new system, your taxable income will be the entire rental amount – the full £1,000. You will then get an allowance against the tax liability for interest (capped at the basic rate of income tax) rather than a deduction against the rental profits. So in effect, landlords may be paying tax on revenue in excess of the true profits after costs.
As alluded to above, the Government has announced plans to reduce tax relief on mortgage interest payments to the basic rate of tax – 20 per cent. Under the current system, landlords paying higher rate tax can claim tax relief on their mortgage interest payments at their marginal income tax rate of up to 45 per cent.
The changes are to be phased in over a four-year period from April 2017, ending in 2020. Each year, in effect, landlords will lose a quarter of their higher rate tax relief.
This all adds up to a major financial headache for many of the UK’s million-plus private landlords, especially those who are higher or top rate taxpayers. Some current basic-rate taxpayers will also be affected if the changes push them into a higher-rate tax bracket.
The tax relief cut is another blow for landlords who have already been hit by April’s stamp duty hike.
Buyers of second homes – whether holiday or buy-to-let properties – now have to pay a 3 per cent stamp duty surcharge. Unlike regular stamp duty, which is charged on a tiered basis, the surcharge will apply to the entire purchase price of the property – and will be in addition to the regular stamp duty bill.
This will apply to all landlords. Under initial proposals, businesses with more than 15 properties were to be exempt from the surcharge, as were situations where the purchase was treated as a commercial property purchase – generally, where 6 or more properties were being purchased in a single transaction. But the Chancellor rejected these proposals in the Budget – for both companies and individuals.
Many landlords have therefore been looking at ways to mitigate the effects, including setting up limited companies.
…one of the key drivers for using a corporate structure is to avoid the restrictions on interest tax relief that are being introduced.
Certainly, one of the key drivers for using a corporate structure is to avoid the restrictions on interest tax relief that are being introduced. However, while starting a company might seem an attractive option, transferring ownership of buy-to-let properties into a corporate can be fraught with complications. It may also not be financially beneficial. There are a number of issues for landlords to consider.
Risks and costs
The first is that if the Government sees huge numbers of individuals applying to bring their buy-to-let properties into a limited company, it may extend the restrictions on interest tax relief to corporate structures too, albeit that companies only get tax relief at 20 per cent anyway.
Secondly, the process of transferring ownership of buy-to-let properties from an individual name to a corporate is not necessarily easy or straightforward. There can be difficulties – and financial complications.
Setting up a limited company also involves other expenses, such as the need to ﬁle annual returns and accounts.
For many buy-to-let businesses, it could result in a big capital gains tax bill. This is probably the biggest stumbling block; HM Revenue & Customs does not consider the passive holding of a rental property as a business for this purpose so the usual tax reliefs on incorporating a business do not apply meaning that when an individual landlord transfers their rental properties to a company, they will be making a disposal of the properties at market value for capital gains tax purposes.
In addition, the Chancellor revealed in the Budget that while capital gains tax would fall from 28 per cent to 20 per cent for higher rate taxpayers and to 10 per cent for basic rate taxpayers from April, this would exclude gains made on residential property.
Setting up a limited company also involves other expenses, such as the need to file annual returns and accounts.
Looking ahead, the ﬁnancial implications of the upcoming changes to taxation may be too much for some landlords and they may decide to exit.
It’s also worth remembering that if you have an existing individual buy-to-let mortgage (with the mortgage in your name) and you want to put it into a corporate, the loan often needs to be discharged and put into the name of the company. This means redeeming the existing mortgage and replacing it with a mortgage taken out by the company.
Buy-to-let mortgages for corporates tend to have higher interest rates and arrangement fees.
Looking ahead, the financial implications of the upcoming changes to taxation may be too much for some landlords and they may decide to exit. However, this may provide buying opportunities for astute landlords. We may see more properties becoming available at lower prices, such that yields can remain attractive despite the interest restrictions and additional SDLT cost.
Whatever their individual decisions, the new rules are going to affect both existing and future landlords – and are likely to change the face of the entire buy-to-let market as we know it.