Summary of tax changes affecting UK Residential Landlords in 2016V1-JC-11062015
Tax has been one of the major worries of landlords throughout the UK over the past year. Many changes have been brought in to much confusion and we often receive calls and requests for information from our members. Our service partners, RITA4RENT have written this guide to provide a summary to help you understand the changes.
It is fair to say that it has not been a good time for a lot of landlords over the last couple of years, as the Government hit hard with wave after wave of tax measures.
The aim of this guide is to bring clarity to some of the changes. Of course, there are so many variables and new laws, that it is impossible to cover everything. However, we shall focus on providing an overview of the key areas. It is highly recommended to seek your own tailored property tax advice if you are concerned as, unfortunately, as with all things tax, there is no one-size-fits-all solution available to landlords.
Stamp Duty Surcharges
One big and recent change involved stamp duty land tax, and the additional surcharge imposed on buy to let investors. This would affect those who purchase residential property, with higher rates affecting those who own two or more residential properties at the end of the day of the transaction, and are not replacing their main residence. As per the guidance, this relates to purchases in England, Wales and Northern Ireland, given the Scottish devolution.
A comparison of the previous rates, and new rates, are summarised below:
|Purchase Price||Previous SDLT rate||New SDLT rate|
|£0 - £125k||0%||3%|
|£125k - £250k||2%||5%|
|£250k - £925k||5%||8%|
|£925k - £1.5m||10%||13%|
If you are able to find a property valued at less than £40k then it is worth mentioning that the higher rates would not apply, nor will it apply to mobile homes, caravans, houseboats or non-residential properties. Those looking to purchase properties via a limited company will also be a target for the new stamp duty surcharges. There is a complex area in relation to our earlier comments with regards replacing a main residence. HMRC's official guidance states that "Purchasers will have 36 months to either claim a refund from the higher rates, or before the higher rates will apply, in the event that there is a period of overlap or a gap in ownership of a main residence".
As previously mentioned, this is a basic summary, and the guidance notes on the stamp duty changes are vast. Therefore, it is strongly advisable to seek professional advice on your own scenario.
Restriction of Financial Costs
One of THE most controversial announcements in recent times affecting landlords, are the changes to treatment of mortgage interest and finance costs.
From April 2017, a 4 year equal phase-in will commence, and mortgage interest will no longer be deductible when calculating your rental profits.
This is applicable to residential property, and so you will not be affected if you operate a Furnished Holiday Let, or a commercial lettings business. It will also not affect those with property in a limited company, but will affect LLPs and partnerships.
Therefore, we shall use a landlord named Mrs Smith as an example. She has rental income of £60,000, repairs/insurance/prof fees of £15,000 and mortgage interest of £40,000.
Under the old rules her profit would be £5,000 but once the new rules are fully phased in, her profit will be £45,000.
Under the new rules, the above profit will be taxed at her income tax rates.
From there, a "reducer" will be applied to the tax owed as calculated above, at the value of 20% multiplied by the mortgage interest paid.
There is a popular misconception that this only affects higher rate taxpayers. However, as well as affecting those, it can also affect those who were previously basic rate taxpayers, but who are now higher rate due to the change in determining profits.
Another point to bear in mind, is that the changes do not just affect mortgage interest, but also finance costs. This includes costs such as mortgage arrangement fees, broker fees and similar.
Let's look at a more in depth example. For these purposes, we shall use the 2014/15 tax thresholds and rates. The reasoning here, is that landlords will have recently completed the tax return for this year, so may help give a good comparison. For the purposes of this example, we are showing the effect for when the rules are fully implemented after the 4 year phase in.
Relevant example figures as follows:
- Employment income £100k with standard PAYE deducted of £29,627, and no adjustments on PAYE coding notice.
- Rental income £44,460
- Non-interest expenses £7,080
- Mortgage interest £24,470
The rental accounts under the current method would show a rental profit of £12,910 - i.e £44,460 - £7,080 - £24,470.
The rental accounts under the new method (once phase in completed), would show a rental profit of £37,380 - i.e. £44,460 - £7,080.
We can add these figures to the before and after scenarios below:
BEFORE - WITH £100k Salary taxed correctly (total income £112,910 i.e including the £12,910 above)
(Personal allowance restricted as exceeded 100k threshold, by £6,455 i.e £12,910 excess divided by 2; personal allowance therefore £3,545
Rental Profit = £12,910
£3,545 @ 0% = £Nil (note the restriction of personal allowance £10k - £6,455 above
£31,865 @ 20% = £6,37
£77,500 @ 40% = £31,00
Total Tax = £37,37
Minus tax paid under PAYE = £29,627
TOTAL TAX OWED (not including payments on account) = £7,74
AFTER - WITH £100k Salary taxed correctly (total income £137,380)
(No personal allowance as fully restricted given exceeded threshold)
Rental Profit = £37,380
£31,865 @ 20% = £6,373
£105,515 @ 40% = £42,206
Less mortgage interest tax adjustment
£24,470 x 20% = -(£4,894)
Total Tax = £43,685
Minus tax paid under PAYE = £29,627
TOTAL TAX OWED (not including payments on account) = £14,058
Therefore, in this example, the tax owed has nearly doubled!
We mentioned a four year phase in, and this is due to commence in April 2017.
The finance costs will be restricted as follows:
- 75% for the tax year ended 5th April 2018
- 50% for the tax year ended 5th April 2019
- 25% for the tax year ended 5th April 2020
- 0% from tax year commencing 6th April 2020.
Great care will need to be taken where losses are involved, and therefore to be clear, the tax "reducer" is calculated as the 20% of the lower of:
- Mortgage interest and finance costs not deducted from income
- Profits less any losses brought forward
- Total income (less savings and dividend income) exceeding the personal allowance
There are many strategies landlords are carrying out in an attempt to limit the damage of these changes, such as starting up limited companies, transferring property to a spouse, making additional pension contributions; it is a long list. However, advice is strongly recommended, as some of these actions may result in other tax implications, and it is a case of looking at your own individual circumstances, ascertaining your future goals, and mapping the most strategic path to achieve those.
Incorporation has become a key consideration for a number of landlords, despite its huge number of pros and cons, but they are generally attracted to the fact that the above finance cost restrictions do not apply. Whilst this may be suitable for future purchases, there lies a problem in moving personally owned property into a company in potentially triggering an immediate capital gain. This is due to the fact that a company is a separate legal entity, and therefore any such transfer would be classified as a "sale". However, the recent Ramsey case did give some landlords a glimmer of hope with regards mitigation, but again, professional advice is essential here.
To finish the section, we leave you with a brief summary of some of the pros and cons of operating a limited company holding investment property:
- Not affected by finance cost restriction changes
- Lower rate of tax, compared to higher rate tax under self-assessment
- Potential indexation allowance claimable
- Favourable rates of capital gains tax compared to 28% for some disposals of personally owned residential property at higher rate
- There can be benefits as far as passing on property to children
- Companies do not receive an annual exemption nor personal allowances
- For those owning property personally, there can be benefits when selling the property, if you have lived there. This is the complete opposite for company owned property, and there can be quite serious consequences if you reside in a company owned property
- Lower tax rates, but this is based on profits. You still need to extract this money from the company, which has tax implications, such as salary/dividends etc. Also, the dividend changes which have recently come into force may affect you
- Greater costs for accountancy fees and more compliance requirements
- Can sometimes be harder to obtain finance, although we are not mortgage advisors, and relevant separate advice should be sought here
Wear and Tear Allowance
Another big change recently is regarding wear and tear allowance.
If you let any of your rental properties out as fully furnished in the 2015/16 tax year, you can claim a 10% wear and tear allowance. HMRC's definition of fully furnished is: "one which is capable of normal occupation without the tenant having to provide their own beds, chairs, tables, sofas and other furnishings, cooker etc". This is calculated as 10% of the net received. Net rent is the rental income received, less any expenses which would normally be borne by the tenant, such as council tax and utility bills. Wear and tear generally works out beneficial, as the allowance can be claimed, even when furnishings are not purchased.
However, HMRC announced the wear and tear allowance is abolished from 6th April 2016 and introduced a new system effective in the 2016/17 tax year onwards. This system will be that instead of claiming a flat rate allowance, you will be able to claim the cost of replacing the furnishings but not the initial cost. We are therefore recommending and advocating rigorous inventory controls and systems, to ensure claims will stand up to HMRC scrutiny. The HMRC guidance states that the replacement has to be like-for-like or the nearest modern equivalent, with them also allowing costs incurred in disposing of the furnishings, but also accounting for any proceeds received for the replacement of the furnishing. It is important to note that this is NOT applicable to furnished holiday lets, given their special tax treatment, and as such, they continue to benefit from the capital allowances regime. As this new system came into force in April 2016, it will not affect those tax returns being completed now, but it will affect the 2016/17 tax year, of which tax returns can be completed from 6th April 2017 up until the tax deadline of 31st January 2018.
Let Property Campaign
And finally, just a reminder that HMRC's Let Property Campaign is continuing. Originally slated to last 18 months when launched back in 2013, it is still continuing due to the sheer success of the campaign. For those unaware, the Let Property Campaign allows landlords to come forward and pay tax on previously undeclared rental profits, benefiting from more favourable terms as far as penalties are concerned.
As we regularly emphasise, it goes without saying that if you have undeclared rental profits, it is best to come forward as soon as possible. HMRC have a wealth of information at their fingertips, and it is very much a case of "when" not "if" they get hold of you.
We hope this feature has been helpful, but to emphasise again, the above is very much scratching the surface, as there is simply too much to cover. If you require any individual tailored advice, and for any of your property tax needs, please do not hesitate to contact RITA4Rent on Freephone 0800 1 22 33 57 or via email email@example.com.