Buy to let investors will see a big change to the way they calculate their profits, and therefore their tax bills from April 17.  Although this is still a year away, you need to understand the changes and how they may affect you if you considering a buy to let or already own one.

 

What are the changes?

Currently, landlords get tax relief for their finance costs against their rental business.

Put simply, you can offset the amount of interest you pay on your buy to let mortgage, (and related fees, commissions and legal expenses) against the rental income from the property.

This reduces the profit of the rental business – and hence your tax bill.  If you are a higher rate tax payer, then you are effectively getting 40 or 45% tax relief on your mortgage interest.

From April 17, new rules mean that all finance costs will no longer be an allowable cost of the business.  Instead, you will have to make a “tax return adjustment” that will give you a basic rate deduction of up to 20% of the finance cost.

 

So in practise – what on earth does that mean?

Let’s look at example to show what the effects are.

If you had rental income of £10,000 in 2016/17 and paid £2,000 in mortgage interest, under the current rules you would have rental profit of £8,000.  If you were a higher rate tax payer, you would pay tax on that at 40%, so £3,200.

The new rules are being phased in over 4 years from April 17 so by April 21 – with the same numbers above, you would have rental profit of £10,000 (as you now get no relief for the mortgage interest).  Tax on this at 40% is £4,000 – and then you get your “adjustment” of 20% of the finance cost (so 20% of £2000 = £400) deducted to give you a final bill of £3,600.  £400 more than it is now.

For basic rate taxpayers there is no change to the tax due BUT you cannot ignore it – as you may find that you actually become a higher rate taxpayer as a result of the changes.

 

Will I become a higher rate taxpayer?

Once the finance costs are disallowed in your rental accounts, obviously your rental profit is going to be higher –and depending on your personal circumstances, this could mean that your total income is pushed into the higher income bracket for tax. This potentially has knock on effects:

  • There could be an impact on tax credits, or child benefit
  • You could end up paying tax at 40%, or capital gains could be taxed at 28% instead of 18%

As I said above, the changes are being phased in over 4 years from April 17 as follows, so there are going to be some complicated tax computations ahead!

 

Year % of finance costs allowed as deduction % of costs available as a basic rate deduction
2017/18 75% 25%
2018/19 50% 50%
2019/20 25% 75%
2020/21 0 100%

 

What can I do about it?

If the loss of higher rate tax relief is going to be really costly to you – the popular alternative solution is to hold and manage your rental property through a limited company, as limited companies are not affected by these new rules.

This could be an option but needs careful consideration as it brings its own set of tax issues.

Transferring existing property into a limited company will give rise to both stamp duty and a capital gain based on market value.  The limited company will only pay corporation tax on its profit (currently 20% and falling to 18% from 2020,) so a lot less than 40% or 45% personal tax, but you still need to extract the money from the company to get it into your hands via either salary or dividends –and there are new tax rules for dividends from April 16 as well!  If the property is sold, the funds go into the company and the company pays the tax, and then you need to extract the money from the company.

If buying a new property through a limited company – you will probably find mortgages harder to find and at higher rates and higher stamp duty in some circumstances.

There are also the admin costs of running a limited company to consider.

 

As if that’s not enough bad news…..

Stamp duty is also changing from 1 April 2016 for second homes or buy to lets so you will pay an additional 3% over the current rates for your main home.  This applies to transactions completed after 1 April 2016 where contracts were exchanged after 25 November 2015 – hence the current rush for completion on deals before 1 April!

The rules are complicated but will affect a lot of buy to let investors.  You need to work through how it is going to affect you personally over the next few years so you can plan accordingly.

 

For more information please contact Rosie Forsyth at Wilkins & Co.