Investment in property has been and continues to be a popular form of investment by many people. Net returns in capital and income will depend on a host of factors and tax has always been a key consideration.
The Government have recently introduced a number of tax changes affecting landlords which we have summarised below. This information should help you to consider what action, if any, you need to take.
Whilst some generalisations can be made about buy to let properties, every individual situation is different. Any plan must take into account your personal circumstances and aspirations.
Property income and interest relief
The surprise announcement in the Summer Budget 2015 restricting income tax relief for interest costs incurred by landlords of residential properties became law in November 2015. Any hopes that the Chancellor would change his mind were dashed in the Autumn Statement in December when additional charges to Stamp Duty Land Tax on purchases and acceleration of capital gains tax on sale were announced.
From April 2017, income tax relief will start to be restricted to the basic rate of tax. The restriction will be phased in over four years and therefore be fully in place by 2020/21. In the first year the restriction will apply to 25% of the interest, then 50% the year after and 75% in the third.
The new rules only apply to residential properties and do not apply to companies or furnished holiday lettings. The restrictions apply to any interest and finance costs and so would also limit mortgage application fees and interest costs on loans to buy fixtures or furniture.
When thinking of investing in a new residential property, careful consideration should be given to the amount of tax relief to decide on the viability of taking on a new loan.
How much extra tax will this mean?
The additional amounts of tax arising will depend on the marginal rate of tax for the taxpayer. Basic rate taxpayers should not be substantively affected by the proposals. A higher rate taxpayer will, in principle, get 20% less relief for finance costs.
However the calculation method may mean that some taxpayers move into higher rate tax brackets. The following example illustrates this situation.
Example
Consider the 2020/21 tax year when the transitional period is over. Let’s assume that the personal allowance is £12,000 and the basic rate band is £38,000 meaning that the higher rate band starts at £50,000. Toni has a salary of £35,000, rental income before interest of £23,000 and interest on the property mortgage of £8,000.
Under the current tax rules, taxable rental income is £15,000. He will not pay higher rate tax as his total income is £50,000 - the point from which higher rate tax is payable.
With the new rules, taxable rental income is £23,000. So £8,000 is taxable at 40% - £3,200. Interest relief is given after having computed the tax liability on his income. The relief is £8,000 at 20% - £1,600. So an extra £1,600 tax is payable.
Can it get worse than this?
Yes it can. Other things to watch for include:
- The amount of the interest relief is restricted where either total property income or total taxable income (excluding savings and dividend income) of the landlord is lower than the finance costs incurred. For example, if net property income is £4,500 before interest of £6,000, the landlord is making a £1,500 loss. Despite this £4,500 is taxable. Also the interest relief is restricted to £4,500 at 20% rather than £6,000 at 20%. The unrelieved interest (£1,500 at 20%) is carried forward and may get tax relief in a later year.
- Child benefit is clawed back if ‘adjusted net income’ of a couple with children is above £50,000. Interest will not be deductible in the calculation of ‘adjusted net income’.
- The personal allowance is reduced if ‘adjusted net income’ is above £100,000.
If you require any assistance or further information about the deduction of interest by residential landlords please do not hesitate to contact us.
Removal of the Wear and Tear allowance
Many businesses receive capital allowances to recognise the depreciation of equipment used in the business. However, there are no capital allowances due for equipment bought for use in a residential property.
There are exceptions to this rule for property which falls within the definition of a furnished holiday letting and expenditure on assets which are used in the non-residential part of a block of flats, for example the hallways.
Since April 2013 where a taxpayer lets a fully furnished residential property, a deduction could only be claimed for a wear and tear allowance of 10% of the ‘net rent’ from the furnished letting, designed to cover the depreciation of equipment.
Furthermore from the same date where a dwelling is let partly furnished, there are no allowances due at all unless costs are incurred on equipment and can be classified as a repair. Relief will then be given for these costs. In some cases, a repair will include the replacement of that item if that item can be regarded as a ‘fixture’ in the building.
Whether expenditure is a repair can be complex and is governed by principles established in a number of tax cases.
From April 2016 the government has removed the wear and tear allowance. A new relief will allow all residential landlords (in respect of a fully furnished dwelling or not) to deduct the actual costs of replacing furnishings provided for the tenant’s use in the residential property. The initial cost of furnishing a property will not be included.
Capital allowances will continue to apply for landlords of furnished holiday lettings.
Below lists the common types of expenditure for the new relief and examples of fixtures which are, and will continue to be, treated as repairs.
Examples of items eligible for new relief for replacement furniture
Under the new replacement furniture relief landlords of all non-furnished holiday let residential dwelling houses will be able to claim a deduction for the capital cost of replacing furniture, furnishings, appliances and kitchenware provided for the tenant’s use in the dwelling house, such as:
- movable furniture or furnishings, such as beds or suites
- televisions
- fridges and freezers
- carpets and floor-coverings
- curtains
- linen
- crockery or cutlery
- beds and other furniture.
Examples of ‘fixtures’ which are eligible for relief as repair expenditure
Fixtures integral to a residential property are not normally removed by the owner if the property was sold. The replacement cost of these are, and will continue to be, a deductible expense as a repair to the property itself. Fixtures include items such as:
- baths
- washbasins
- toilets
- boilers
- fitted kitchen units.
Stamp Duty Land Tax (SDLT)
The Chancellor announced in the Autumn Statement that new rates of SDLT on purchases of additional residential properties would apply from 1 April 2016.
The new rates will be three percentage points above the current SDLT rates. The higher rates will potentially apply if, at the end of the day of the purchase transaction, the individual owns two or more residential properties.
The SDLT proposals were subject to a consultation. The government has now announced:
- purchasers will have 36 months rather than 18 months to replace their main residence
- a small share in a property which has been inherited within the 36 months prior to a transaction will not be considered as an additional property when applying the higher rates
- there will be no exemption from the higher rates for significant investors.
Comment
The main target of the higher rates is purchases of buy to let properties or second homes. However, there will be some purchasers who will have to pay the additional charge even though the property purchased will not be a buy to let or a second home. The proposed 36 month rules above will help to remove some transactions from the additional rates (or allow a refund). Care will be needed if an individual already owns, or partly owns, a property and transacts to purchase another property without having disposed of the first property.
Married couples are treated as one unit and therefore a purchase by one spouse of their first property will be subject to the additional 3% if the other spouse has a property.
Also, for joint purchasers, if any one of them has more than one property at the end of the transaction the entire purchase price is subject to the extra 3%.
SDLT on non-residential property
The government will change the calculation of SDLT on freehold and leasehold premium non-residential transactions, on and after 17 March 2016, so the rates apply to the portion of the purchase price within each band. The SDLT rates and thresholds for non-residential freehold and leasehold premiums will also change from the same date.
For new leasehold transactions, SDLT is already charged at each rate on the portion of the net present value (NPV) of the rent which falls within each band. On and after 17 March 2016 a new 2% rate for rent paid under a non-residential lease will be introduced where the NPV of the rent is above £5 million.
Property and trading income allowances
From April 2017, the government will introduce a new £1,000 allowance for property and trading income. Individuals with property or trading income below £1,000 will no longer need to declare or pay tax on that income. Those with income above the allowance will be able to calculate their taxable profit either by deducting their expenses in the normal way or by simply deducting the relevant allowance.
Capital gains tax (CGT) rates
The current rates of CGT are 18% to the extent that any income tax basic rate band is available and 28% thereafter. The government is to reduce the higher rate of CGT from 28% to 20% and the basic rate from 18% to 10%. The trust CGT rate will also reduce from 28% to 20%. The 28% and 18% rates will continue to apply for carried interest and for chargeable gains on residential property that do not qualify for private residence relief. In addition, the 28% rate still applies for ATED related chargeable gains accruing to any person (principally companies). These changes will take effect for disposals made on or after 6 April 2016.
Capital gains tax: payment window
From April 2019, a payment on account of any CGT due on the disposal of residential property will be required to be made within 30 days of the completion of the disposal. This will not affect gains on properties which are not liable for CGT due to Private Residence Relief.
Comment
Currently, CGT is not payable on a disposal of an asset until 31 January following the tax year in which a disposal is made. So a disposal made on the 6 April 2016 will not result in a tax bill until 31 January 2018. This measure is another blow for buy to let landlords.
How we can help
Whilst a successful buy to let cannot be guaranteed, professional advice can help to sort out some of the potential problems and structure the investment correctly.
We would be happy to discuss buy to let further with you. Please email Debbie Franklin at debbief@peplows.co.uk or call 01392 223930.