There have been major recent changes that are set to significantly affect the profitability of buy-to-let properties affecting private client landlords and property investors.
A change to mortgage interest relief has been announced. Currently, an investor can claim the interest element of their loan repayments against their profits from a buy to-let. This is to be removed as from 6th April 2017, gradually over four years and being replaced with a tax credit of 20% of the lower of:
- the finance costs,
- the profits of the property business or
- total income that exceeds the personal allowance in the tax year.
On the face of it, this doesn’t seem that radical but it could substantially increase an investor’s tax liability depending on their gearing.
Take a rental portfolio generating an income of £25,000 with no associated costs, other than loan interest of £15,000, leaving a profit subject to tax of £10,000. Currently, assuming the investor has other income using his allowances and is a higher rate taxpayer, this would see the profit of £10,000 generating a tax bill of £4,000. Under the new rules, the income of £25,000 will now be taxable profit at 40% so £10,000, less the tax credit of £3,000 (20% of £15,000) giving an overall tax bill of £7,000 i.e. an increase of £3,000 or 75%.
The problem is exacerbated when the taxpayer is close to the next income tax band. If, as in the previous example, the taxpayer had been a basic rate taxpayer on the £10,000 instead of profit/income of £10,000 the taxpayer will have profit/income of £25,000, £15,000 of which could now be taxed at 20 % (i.e. 40% less the 20% credit) rather than not taxed at all.
In the March 2016 Budget, the Chancellor announced a reduction in Capital Gains Tax (CGT) to 20% for higher rate taxpayers but this does not apply to property assets that are still taxed at the 28% rate.
The change will not affect those operating their business through a limited company where finance costs will still be allowed. The taxpayer could consider altering their business structure but the practicalities will need to be considered. Would the loan interest increase? Would Stamp Duty Land Tax be payable? If there is a property partnership it may be possible to make the transfer and claim the partnership exemption. CGT may also be able to be held over.
It is important to note the above changes do not affect furnished holiday lettings that are regarded as a trade.
Property investors clearly need to examine their portfolio and decide how the coming changes to mortgage interest tax relief will affect them and we would be happy to help them with the restructuring of their property portfolio.
For further advice or assistance please contact Wilson Browne Solicitors.